Hello there,

A fantastic Friday to you as markets flail in the wake of the prospect of the U.S. Federal Reserve raising rates by 50 basis-points in May, despite money market managers already having priced in such a hike.

In brief (TL:DR)

• U.S. stocks were a sea of red on Thursday with the Dow Jones Industrial Average (-1.05%), S&P 500 (-1.48%) and the Nasdaq Composite (-2.07%) all lower as hawkish comments from the U.S. Federal Reserve Chairman Jerome Powell and surging bond yields spooked investors.

• Asian markets were hammered on Friday morning on the prospect of one of the most aggressive Fed tightening cycles in modern history.

• Benchmark U.S. 10-year Treasury yields soared to 2.94% on Fed tightening fears that saw yields soar across the board (yields rise when bond prices fall).

• The dollar rose.

• Oil sank with May 2022 contracts for WTI Crude Oil (Nymex) (-1.05%) at US$102.70 on concerns of slowing growth in China and fears that the Fed may tip the U.S. economy over into recession because of over-tightening policy measures.

• Gold was more or less unchanged with June 2022 contracts for Gold (Comex) (+0.31%) at US$1,954.30.

• Bitcoin (-2.42%) slipped to US$40,600 along with other risk assets as the prospect of higher borrowing costs from an increasingly hawkish U.S. Federal Reserve tamped down appetite for the benchmark cryptocurrency.

In today's issue...

1. China's Emperor Fiddles while Its Economy Burns

2. Half-Point Told You So

3. Russia's Cryptocurrency Sector Not Sanction-Proof

Market Overview

The Kremlin appears to be taking a leaf out of the playbook of Pyongyang as Russia test fires a nuclear-capable ICBM in a warning to the U.S. and its allies.

But if markets or Western allies are concerned, this was not at all obvious, with Washington responding that the Russian ICBM did not exceed any capability that the U.S. already possessed.

If nothing else, Moscow's test-firing of an ICBM as its troops get bogged down in Ukraine are symptomatic of a regime that is in decline - real power is expressed through having a big stick but not needing to wave it around.

To be sure, Russia always had the capability to nuke targets in the West, having an "additional" ICBM that can do so isn't that big a deal and Western missile defense systems, while a laudable effort, are nothing close to some kind of impenetrable force shield.

Which is why markets are barely budging in response, but paying greater attention to the possibility that inflation may already have peaked.

It may seem disingenuous to believe that inflation is at its nadir but there is a growing view that the post-pandemic surge in demand and rehabilitated supply chains may be slowing the pace of price increases - controversial no doubt, but has been the fuel that is driving a sharp rebound in bonds.

Asian markets were mostly higher in Thursday's morning trading session with Seoul's Kospi Index (+0.59%), Tokyo's Nikkei 225 (+1.29%), Sydney’s ASX 200 (+0.27%) in the green while Hong Kong's Hang Seng Index (-0.35%) continued to suffer a bout of selling as global investors grow increasingly concerned about Beijing's overreach into China's tech sector through fresh data laws.

1. China's Emperor Fiddles while Its Economy Burns

• The People's Bank of China fails to deliver on key rate cuts even as there are growing signs that the Chinese economy is slowing because of debilitating zero-Covid lockdowns.

• Global investors are continuing to pull money out of China as there appears to be no end in site for Beijing's zero-Covid policies and with infections soaring thanks to a lethal combination of ineffective vaccines and low vaccination rates.

In July of 64 A.D. as a great fire ravaged Rome, it’s Emperor, Nero, fiddled while the eternal city burned.

Fast forward to our current epoch, and another emperor is looking on while his economy burns.

Despite numerous pleas from countless quarters to ease up on its draconian zero-Covid policies, Chinese President Xi Jinping has doubled down.

Worse still, Xi’s government has held back support for the economy through stimulus, even as industrially and commercially important cities are put under harsh lockdown, making Beijing’s goal of 5.5% growth this year look increasingly aspirational than achievable.

Meanwhile the promise of support by way of stimulus from the People’s Bank of China (PBoC) has fallen far short of the minimum needed to stimulate the moribund economy and extended a rout in Chinese stocks.

On Thursday, the benchmark CSI 300 Index fell by 1.8%, capping off a fifth consecutive day of losses.

Meanwhile, Xi defended Beijing’s lockdown-dependent approach to fight the pandemic, in a speech at the opening ceremony of the Boao Forum for Asia.

In mid-March, promises by Chinese Vice Premier Liu He to stabilize markets saw the benchmark CSI 300 surge, as investors bet on stimulus by Beijing and the central bank, gains which have since been completely evaporated.

Global investors have already sucked out around US$6 billion from Chinese stocks in the first three months of this year alone, but that may just be the start.

In March, foreign investors dumped US$7 billion of shares onshore through China’s stock connect, the most in two years.

Investors who had expected Beijing to ramp up stimulus have been underwhelmed with Wednesday’s decision by the PBoC to keep lending rates unchanged and it doesn’t help that Beijing has reiterated its commitment to Russia and refused to condemn its unprovoked invasion of Ukraine.

Many foreign investors who have left Chinese assets may never come back as the list of risks grows.

From arbitrary and overnight policy shifts to China’s unforgiving pandemic lockdowns, Beijing’s continued backing of its partnership with Russia also increases the risk that there may be a backlash on China’s economy akin to the Western sanctions against Russia.

Given that the risks facing the global economy are already myriad, with high inflation and policy tightening in rich countries weighing on risk appetite, Chinese assets are just too high on the risk spectrum at the moment.

2. Half-Point Told You So

• U.S. Federal Reserve Chairman Jerome Powell confirms money market manager sentiment that the central bank is set to hike rates by 50 basis-points in May.

• Most estimates put at least one 0.50% hike in rates in May, one in June, but the outlook for July remains debatable as policymakers attempt the unlikely - a soft landing for what they view is an overheated U.S. economy.

Just yesterday, this newsletter suggested that investors should be thankful if the U.S. Federal Reserve raised interest rates by 50 basis points in May and money market managers were already pricing in such a hike.

Yet somehow, markets were taken aback when U.S. Federal Reserve Chairman Jerome Powell reiterated what many knew all along, that a 0.50% increase in rates was on the cards.

At an IMF-hosted panel on Thursday in Washington, Powell noted,

“I would say that 50 basis points will be on the table for the May meeting.”

More importantly, Powell was of the view that demand for workers was “too hot” which suggests that the needle has swung to the other end, on concerns that wage hikes could set off a wage-price spiral of inflation that runs away from anything monetary policy can solve.

With the Fed facing down the hottest pace of inflation in over four decades, Powell suggested that “one or more” 50 basis point hikes could be appropriate to reign in price pressures.

Which suggests that the Fed isn’t necessarily out to raise the bar to 50 basis points as the table stakes for every policy meeting, something that Powell himself alluded to when he noted,

“There’s something in the idea of front-end loading.”

Meaning that while the central bank may hike by 0.50% in May, that doesn’t necessarily mean that every meeting there after for the rest of this year will start from this point.

So far, investors are betting on half-point hikes in May, June and possibly July, but beyond that the jury is still out on where policy is headed.

And while policymakers want to achieve a Goldilocks landing for the U.S. economy, not so loose that inflationary pressures increase, but not so tight as to trigger a recession, they’re using the most ill-suited tool to achieve it – monetary policy.

Monetary policy is the equivalent of using a jackhammer to crack open a walnut and hoping that there’s something left to eat at the end of the exercise and risks are piling up that policymakers will get it wrong.

3. Russia's Cryptocurrency Sector Not Sanction-Proof

• Latest round of Western sanctions against Russia target its US$124 billion cryptocurrency sector.

• Centralized exchanges like Binance announce that they will start to crack down on the cryptocurrency loophole that Russians may have been using to evade Western sanctions while Washington targets Russia's lucrative cryptocurrency mining sector.

Soon after Russia invaded Ukraine, the world was shocked by how quickly Western allies came together with a debilitating package of sanctions on Russia above and beyond anything that the world had ever seen before.

Overnight, Russia was denied access to its sizeable dollar-denominated foreign reserves and ordinary Russians were lining up at banks as the ruble plummeted.

An unlikely beneficiary of the economic chaos were cryptocurrencies, with ruble-cryptocurrency pairs taking off, especially against stablecoins like the Tether which is pegged to the U.S. dollar, but also Bitcoin and Ether as well, as Russians raced to preserve the value of their assets.

But the ability of cryptocurrencies to potentially blunt the effect of Western sanctions on Russia was a loophole that Washington and Brussels remained well-aware of.

With its latest package of sanctions, Western allies are looking to close that loophole and yesterday, Binance, the world’s largest cryptocurrency exchange by trading volume, announced that it would curb services to Russians with cryptocurrencies worth more than 10,000 euros, in response to fresh European Union restrictions.

Separately, Washington has sanctioned BitRiver, which operates cryptocurrency mining facilities that allegedly mints over half of all cryptocurrencies mined in Russia.

These measures could disrupt Russia’s lucrative cryptocurrency market, which Russian Prime Minister Mikhail Mishustin estimated was worth US$124 billion this month, but is likely larger.

Since Russia’s 2014 annexation of Crimea, which was formerly part of Ukraine, ordinary Russians have taken to cryptocurrencies both as a means to hedge against future economic uncertainty, but also in case they would ever need to leave Russia in a hurry.

According to estimates from the Kremlin, as many as 17% of all Russians hold cryptocurrencies and the latest move by Western allies to sanction Russia’s cryptocurrency sector could have serious implications on what remained a loophole to blunt their efficacy.

Although Russia is one of Binance’s top five markets globally, less than 50,000 Russian accounts actually hold more than 10,000 euros’ worth of cryptocurrencies and of course one way to circumvent the fresh restrictions is to never leave too much inside to begin with.

Being an exchange, Russians looking to spirit money out of the country would simply use cryptocurrency exchanges like Binance to swap out of the ruble or convert to other cryptocurrencies and send these either to wallet addresses or other offshore exchanges.

Last year, Russia was the world’s third largest cryptocurrency mining venue globally, behind the U.S. and Kazakhstan, after China banned the activity and miners decamped to other countries.