Hello there,

A terrific Tuesday to you as stocks drop as US-China tension stirs haven demand.

In brief (TL:DR)

• U.S. stocks closed lower on Monday with the Dow Jones Industrial Average (-0.14%), S&P 500 (-0.28%) and the Nasdaq Composite (-0.18%) all down.

• Asian stocks retreated Tuesday amid escalating US-China tension over Taiwan and deepening worries about a global economic slowdown, risks that are supporting demand for Treasuries as a haven.

• Benchmark U.S. 10-year Treasury yields declined five basis points to 2.52% (yields fall when bond prices rise).

• The dollar was firmed.

• Oil fell with September 2022 contracts for WTI Crude Oil (Nymex) (-0.88%) at US$93.06 on concerns over Chinese demand.

• Gold was higher with December 2022 contracts for Gold (Comex) (+0.16%) at US$1,790.60.

• Bitcoin (-1.76%) fell to US$22,898 having failed to convincingly stage a push over the US$24,000 level of resistance and forcing a retrace despite strength in other risk assets.

In today's issue...

1. Short Japanese Yen Trade Unwinds

2. European Shares See Muted Gains as Serious Challenges Remain

3. Bitcoin Miners Regain Footing

Market Overview

Investors are also keeping a wary eye out for more potentially hawkish comments from Federal Reserve officials about the need for higher interest rates to restrain elevated inflation.

Expectations for how aggressive the Fed must be have receded because of recession risk, so any shift in those perceptions could stoke market volatility.

Asian markets were lower on Tuesday with Sydney’s ASX 200 (+0.07%) up slightly, while Seoul's Kospi Index (-0.51%), Tokyo's Nikkei 225 (-1.42%) and Hong Kong's Hang Seng Index (-2.52%) all down.

1. Short Japanese Yen Trade Unwinds

• The yen rose as much as 1%, yesterday, but still fell short of dipping below 132 against the dollar, a key level of resistance that would signal the worst may be over for what has long been a haven currency.

• Japanese inflation is picking up, but remains far more muted compared with the U.S. and Europe, giving the Bank of Japan some degree of headroom in maintaining its accommodative policy.

The yen may be down but is far from out as investors start looking for havens again with U.S. Treasury yields starting to top off.

Well on its way to achieving its longest rally since February, one of the largest macro trades of the year is tapering off as bets against the Japanese yen became overcrowded.

The yen rose as much as 1%, yesterday, but still fell short of dipping below 132 against the dollar, a key level of resistance that would signal the worst may be over for what has long been a haven currency.

Hedge funds are selling dollar positions and increasing yen purchases as U.S. Treasuries rallied on reduced expectations of aggressive U.S. Federal Reserve rate hikes with the threat of a recession looming on the horizon.

The yield gap that had opened up between the U.S. and Japan which aided in bringing the yen to a 24-year low, has since narrowed and some strategists are pricing in a yen-dollar peak.

Yen demand may be durable even in the face of persistent inflation and a Fed that remains hawkish as growth concerns would put a lid on long-dated Treasury yields, making currencies like the yen and the euro somewhat more attractive.

The spread between the 10-year real U.S. Treasury yields and their Japanese counterparts has contracted to 0.80% from 1.5% during June.

Net-short futures and options positions on the yen have dipped to their lowest levels since March 2021, owing to leveraged funds exiting an already overcrowded trade.

To date, Japan’s currency resides at the bottom among Group 10 peers, dipping around 13% this year as the Bank of Japan maintains low interest rates in contrast to the Fed’s rate hikes.

Japanese inflation is picking up, but remains far more muted compared with the U.S. and Europe, giving the Bank of Japan some degree of headroom in maintaining its accommodative policy.

Japan’s policymakers are well aware of the dangers to the Japanese economy which is only just coming out of decades’ long slumber after the bursting of a real estate bubble in the 1990s led to the country’s “lost years.”

Tokyo will be keen to avoid a repeat the decades of low growth and stagnation, especially when the green shoots of an economic revival remain possible.

2. European Shares See Muted Gains as Serious Challenges Remain

• Europe’s benchmark Stoxx 600 index only inched a meager 0.2% higher on Monday, despite a far more robust rebound for embattled global equities in July with markets reacting to an economic slowdown and awaiting the easing inflation.

• European companies are likely to see muted earnings in the coming quarters and investors are bracing for the region to slip back into more modest and moderate levels of growth.

Although global stocks rebounded on the prospect of a more benign U.S. Federal Reserve rate hike cycle, underwhelming Chinese factory data has clouded the outlook for European companies, for which China is a major market.

Europe’s benchmark Stoxx 600 index only inched a meager 0.2% higher on Monday, despite a far more robust rebound for embattled global equities in July with markets reacting to an economic slowdown and awaiting the easing inflation.

Official data released over the weekend showed that Chinese factory activity shrunk unexpectedly in July after fresh pandemic lockdowns continued to weaken demand in China’s already embattled real estate sector.

China’s real estate sector is estimated to contribute to 29% of GDP and affects as much as 70% of economic output through ancillary demand for other related industries, including everything from building materials to marketing services.

Chinese homebuyers withholding mortgage payments and contractors refusing to work until developers pay them have had a detrimental effect on European companies, which are suppliers of everything from building materials and appliances to luxury cars to match new apartments.

Europe also faces fresh challenges from the coming winter, with a war in its backyard and Moscow’s continued threats to cut off natural gas supplies to the continent, threatening to plunge the eurozone into the cold and darkness and freezing its key export industries.

Inflation in the eurozone is already hitting record levels and there is growing discontent amongst populations at the rising cost of living, which have so far seen the Italian prime minister forced to resign.

Unlike the U.S., there’s only so much the European Central Bank can do to rein in the pace of price increases, with a recent 50-basis-point hike the highest in decades, and coming at the cost of a region where economic conditions differ vastly from the north to the south.

European companies are likely to see muted earnings in the coming quarters and investors are bracing for the region to slip back into more modest and moderate levels of growth.

3. Bitcoin Miners Regain Footing

• With the rebound in Bitcoin in July, the odds of more miners returning is a positive sign that a key sector in the cryptocurrency industry is venturing that a bottom may already have been priced in.

• An increase in difficulty suggests a growing number of Bitcoin miners are willing to secure the Bitcoin blockchain at current prices, indicative of a tentative bottoming.

While it’s been said that markets have bottomed when the last bull becomes a bear, another key metric eyed closely by cryptocurrency investors is Bitcoin mining difficulty.

And with the first Bitcoin difficulty increase since June set to occur this month, miners who had otherwise been sitting out the recent carnage in the markets look set to toss their hats back in the ring once again.

Bitcoin miners from Texas to Tajikistan have turned off their rigs as energy prices soared thanks to inflation and the Russian invasion of Ukraine, as well as heat waves which have increased demand for energy to cool homes and offices.

Older mining rigs and inefficient, overleveraged miners have shut down, some permanently, decreasing hash rate and bringing down the difficulty for mining Bitcoin.

But with the rebound in Bitcoin in July, the odds of more miners returning is a positive sign that a key sector in the cryptocurrency industry is venturing that a bottom may already have been priced in.

More analysts are predicting that as long as there are no fresh lows for Bitcoin, the slowdown in mining activity ought to end either this month or next with some onchain signals already noticeable.

Bitcoin mining difficulty looks set to increase within the next two days, after three straight consecutive difficulty downgrades.

Mining difficulty increases when more people mine Bitcoin and decreases when less people put computing power towards securing the Bitcoin blockchain.

An increase in difficulty suggests a growing number of Bitcoin miners are willing to secure the Bitcoin blockchain at current prices, indicative of a tentative bottoming.