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Weekend Edition 5-6 February 2022 (10-Minute Read)

Hello there,

A wistful weekend to you as stocks wind higher in their first week of February but the threat of far tighter monetary policy looms.

In brief (TL:DR)

  • U.S. stocks finished mostly higher on Friday with the Dow Jones Industrial Average (-0.06%), down a touch but the S&P 500 (+0.52%) and the Nasdaq Composite (+1.58%) rallying higher on the back of a strong performance by Amazon helping to lift sentiment for tech shares.

  • Asian markets closed higher on Friday as tech shares recovered in the U.S.

  • Benchmark U.S. 10-year Treasury yields soared to 1.913% (yields rise when bond prices fall), as the strong jobs numbers from the U.S. Labor Department set the stage for potentially more aggressive policy tightening in March.

  • The dollar rose from a two-week low, tracking gains in Treasury yields.

  • Oil continued to rise with March 2022 contracts for WTI Crude Oil (Nymex) (+2.26%) at US$92.31 threatening to spillover into already heightened inflationary pressures.

  • Gold was flat with April 2022 contracts for Gold (Comex) (+0.21%) at US$1,807.80.

Bitcoin (+9.87%)staged a dramatic rebound to US$41,600 over the weekend, possibly in response to a resurgence in appetite for tech stocks and the specter of higher inflation feeding into multiple narratives.

In today's issue...

  1. U.S. Jobs Report Adds to the Confusion

  2. Where have all the retail traders gone?

  3. The U.S. SEC's Covert Cryptocurrency Regulations

Market Overview

It's official, the U.S. jobs picture is getting better and better.

Although early estimates and the ADP Research Institute report showed a slowing labor market in the U.S., adjusting for seasonal variations (seasonally in-demand jobs over Christmas and Thanksgiving typically end when school starts) paints a picture of a tight American labor market.

And that means that initial bets on the U.S. Federal Reserve having plenty of room to hike rates however they deem appropriate are starting to crystalize, with speculation increasing that the U.S. Federal Reserve will even hike to 0.50% in March.

Ironically, because stocks and other risk assets (even Bitcoin!) appear to have taken inflation, labor and potential interest rate hikes in their stride, the Fed may be more emboldened to get aggressive on price pressures, setting the scene for possible policy errors, or maybe not at all.

While this may sound like it's coming out of left field, could the Fed have their cake and eat it?

Where stocks rise, jobs grow, and interest rates rise even as inflationary pressures recede?

Given the peculiarities of the past 18 months, anything is possible and as the days and weeks go on, it may just be possible for the Fed to conjure up a Goldilocks outcome.

Meanwhile Asian markets enjoyed respite on Friday with Tokyo's Nikkei 225 (+0.73%) and Sydney’s ASX 200 (+0.60%), Seoul's Kospi Index (+1.57%) and Hong Kong's Hang Seng Index (+3.24%) all closing the week higher.

1. U.S. Jobs Report Adds to the Confusion

  • Conflicting U.S. jobs reports from the Labor Department and the ADP Research Institute meant that investors couldn't be sure if jobs had done well or poorly in the early stages of the release of that data

  • Likely that job numbers were strong in January, despite all estimates to the contrary - seasonal variations and the smoothing out of data has reflected a far more robust labor market in the U.S. than early estimates tend to suggest and set the scene for rate hikes

It was the best of times, it was the worst of times, but most of all, it was at the same time.

In a week that was not short on volatility, investors had to contend with two dramatically conflicting jobs reports, one from the ADP Research Institute, which showed that the number of jobs created in the U.S. tumbled in January and one from the U.S. Labor Department that suggested payrolls grew at a surprisingly brisk pace.

So who’s telling the truth?

ADP Research Institute reported that U.S. companies slashed over 300,000 jobs in January, while the U.S. Labor Department claimed that businesses added over 450,000 fresh jobs.

Not since 2015, when the world struggled with whether the dress was black and blue or white and gold has the same set of data yielded such diametrically opposite results.

But on closer inspection, that discrepancy of around 700,000 may not seem so stark because of the seasonal adjustments that the U.S. Labor Department makes to better depict the baseline trend of the economy.

This “smoothing out” the statistical imperfections may look like cooking the books, but it’s quite a common tool the same way that a logarithmic scale makes it possible to fit all the data on a single chart.

And adjustments to previous months also reflected a U.S. economy that is hungry for workers.

The uncertain impact of the Omicron variant and seasonal adjustments has made predicting job numbers almost akin to divination and economic soothsayers have had to resort to just about everything from Tarot cards to goat entrails to forecast job numbers.

Investors are also watching job numbers more closely than ever before, as they try to figure out whether weaker job growth will shake the U.S. Federal Reserve’s apparently steely resolve in its hawkish pivot.

Overall, economists underestimated how much businesses would retail workers and overestimated how many workers would drop off due to Omicron.

But in defense of the forecasts, indicators leading up to the U.S. Labor Department’s findings seemed to suggest that jobs would be hit in January, with jobless claims surging the most in nearly 10 months in the week that the report was released.

Regardless of the jobs report and whichever one that investors want to use as a reference point, most investors have already priced in a 25-basis point rate hike by the U.S. Federal Reserve in March to combat the worst inflation in 40 years.

And with job numbers the way they are, more investors are bracing for a hike of as much as 0.50% in March.

2. Where have all the retail traders gone?

  • Retail traders run out of numbers and money to seriously affect the U.S. equity markets as institutional investors return to the forefront

  • Heavy sell down by professional investors meant that retail traders have been largely whipsawed by the volatility

Where have all of retail gone?

Long time passing?

Where is their meme stock throng?

Long time ago.

– Sung to the tune of “Where Have All the Flowers Gone” by Pete Seeger

Given that at its peak, retail traders made up as much as one in four of every trade on U.S. stock exchanges, more professional investors have been paying attention to retail swings than at any other point in the past.

Unlike many Asian stock exchanges, for decades, retail flows into U.S. stocks has generally been a trickle, with the vast majority of trading being conducted by hedge funds and other institutional investors.

But all that changed in a heartbeat when stimulus checks fell like manna from heaven into the hands of American households and slick digital brokerage apps like Robinhood Markets made trading almost like playing a mobile game.

What ensued was one of the most well-worn David vs Goliath stories in financial market history, when retail investors with no clear leader, banded together to punish short sellers of video game retailer GameStop, sending its stock wildly higher and inflicting billions of dollars of pain on the so-called “smart money” with Melvin Capital, the unfortunate short seller in the cross hairs of the mom-and-pop trader nursing losses of over 40% last year.

But fast forward a year later, and things have changed dramatically.

The stimulus checks have been all but spent, or stuck inside unprofitable positions in the stock market and institutional investors are striking back.

Many of the retail crowd’s favorite speculative tech stocks have fallen dramatically as hedge funds drove a brutal selloff at the start of this year.

The prospect of tighter U.S. monetary policy is also forcing a reordering of institutional portfolios, creating a landscape that is less favorable to day-trading retail investors, accustomed to buying the dip and selling the rally.

Bearing in mind that although retail investors were a significant source of flow at their peak, they were never in the majority and are now badly outnumbered and overwhelmingly outgunned.

Volatility does not favor most retail trading styles, as most day traders sitting in their garages or basements tend to favor long positions and aren’t as skilled using options and futures to hedge their bets in both directions.

Other metrics like earnings announcements, valuation and guidance are also starting to muscle out Reddit postings, tweets and TikTok videos.

Retail investing has also slowed somewhat, with flows now estimated to be just under a fifth of all transactions, some ways off the pandemic peak.

Nevertheless, retail traders, while on the ropes, are not down for the count, sending a net US$41 billion into stocks last month, according to estimates from Morgan Stanley, even as hedge funds shed holdings on concerns that higher interest rates would batter their reliable winners like tech stocks.

3. The U.S. SEC's Covert Cryptocurrency Regulations

  • U.S. Securities and Exchange Commission releases an unrelated plan that could make it easier for the agency to encroach on the cryptocurrency sector, whether through stablecoins or decentralized finance

  • Generous wording of the proposed regulatory plan gives the SEC quasi-legislative powers in bringing aspects of the cryptocurrency sector under its purview

Last week, the U.S. Securities and Exchange Commission issued a 654-page plan aimed at regulating “Treasury market platforms” that most in the cryptocurrency space would have glossed over.

But so-called “Crypto Mom” Hester Pierce, the lone Republican on the U.S. Securities and Exchange Commission warned that the “Treasury market platforms” proposal contained expansive language that could also give regulators sweeping new powers to scrutinize digital asset platforms as well, including decentralized finance or DeFi.

In an emailed statement to Bloomberg, Pierce warned,

“The proposal includes very expansive language, which, together with the chair’s apparent interest in regulating all things crypto, suggests that it could be used to regulate crypto platforms. The proposal could reach more types of trading mechanisms, including potentially DeFi protocols.”

U.S. Securities and Exchange Commission Chairman Gary Gensler said in a statement at the time that the plan was released that it would extend existing regulations to more platforms that trade Treasuries and other government securities.

One of those platforms would be stablecoin issuers like Tether, which manages the world’s most widely used stablecoin tied to the U.S. dollar.

Tether has been dogged by allegations that it has never been tied effectively backed by 1-to-1 by the dollar, and last year settled with the New York Attorney General’s Office to make quarterly disclosures on its holdings that are alleged to back each Tether.

A close inspection of those holdings reveals that Tether holds U.S. Treasuries, which according to the SEC’s latest plan, would then fall under the ambit of their jurisdiction.

Tether is widely used in the DeFi space and serves as one of the most liquid trading pairs for other cryptocurrencies.

But beyond the impact to Tether, the SEC’s plan would “expand Regulation ATS for alternative trading systems (ATS) that trade government securities, NMS stock and other securities.”

One of the main concerns would be that “other securities” could be broadly extended to include most if not all cryptocurrencies.

The SEC’s Gensler has long maintained that he believes many cryptocurrencies are de facto securities, and therefore fall under the regulatory purview of his agency.

Gensler has also frequently stated his desire in wanting cryptocurrency exchanges to register with the SEC, indicating that he planned to closely scrutinize those that declined such oversight.

It’s apparent from the SEC’s proposed plan that Gensler intends to make good on such promises.

Short of Capitol Hill deigning it necessary to divert some of their attention to cryptocurrencies, Gensler, the new sheriff in town isn’t waiting around to see laws for the nascent asset class get made up, preferring to enact his own brand of justice and oversight instead.

Such moves by Gensler are both good and bad.

The SEC is singularly ill-equipped to make determinations on the legislative framework by which cryptocurrencies should be regulated – it’s an enforcement agency, not a lawmaking body.

If the U.S. Congress hasn’t determined that it’s in the interest of the American people to pursue a comprehensive set of legislation to govern the cryptocurrency space, it is not with Gensler’s purview to act unilaterally on behalf of the people.

Far from bringing in the certainty that would draw more mainstream adoption of cryptocurrencies, Gensler’s piecemeal attempt to regulate cryptocurrencies could generate even more uncertainty.

Because participants will never know for sure what law they may be in breach of, or whether they are in breach, factors that could stymie innovation and even drive America’s brightest crypto-entrepreneurs further offshore to countries with more accommodating and clear regulations, this latest move is really more of the same.

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