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Daily Analysis 27 June 2022 (10-Minute Read)

Hello there,

A magnificent Monday to you as expectations of milder central bank policy tightening, given the patchy economic data that is being thrown out, has fueled a relief rally, whose durability is nonetheless uncertain.

In brief (TL:DR)

  • U.S. stocks marked their first week of gains in months last Friday with the Dow Jones Industrial Average (+2.68%), S&P 500 (+3.06%) and the Nasdaq Composite (+3.34%) all higher, with the tech-heavy Nasdaq Composite rising the fastest since March.

  • Asian equities kicked off the waning days of June in the green, buoyed by gains in Chinese and Japanese firms.

  • Benchmark U.S. 10-year Treasury yields dipped to 3.155% (yields fall when bond prices rise) as investors embraced sovereign debt on increasing global economic uncertainty.

  • The dollar slipped in Asian trading.

  • Oil gained with August 2022 contracts for WTI Crude Oil (Nymex) (+0.50%) at US$108.16 as Chinese economic data improved in June, prompting expectations for increased consumption.

  • Gold gained with August 2022 contracts for Gold (Comex) (+0.38%) at US$1,837.30.

  • Bitcoin (-1.16%) slipped to US$21,149, as brief rallies were met by selling pressure from cryptocurrency miners who are having to grapple with increasing costs.

In today's issue...

  1. It's Not Policy that will Spark a Recession, It's Uncertainty

  2. A week of relief for markets, but is it durable?

  3. Could the bottom come when the last Bitcoin Miner becomes a bear?

Market Overview

Global stocks are extending a climb on Monday as the battered tech sector has made a surprising comeback on bets that inflation may be peaking while central banks have to contend with rising recessionary risks and may not turn as strongly hawkish as anticipated.

Chinese tech firms soared while Japanese shares gained against a backdrop of supportive policies and regulatory easing.

Importantly, U.S. Treasury yields have not run away as initially feared, feeding risk appetite and helping market sentiment.

Asian markets opened higher on Monday with Tokyo's Nikkei 225 (+1.04%), Seoul's Kospi Index (+1.81%), Hong Kong's Hang Seng Index (+2.65%) and Sydney’s ASX 200 (+1.69%) up in the morning trading session.

1. It's Not Policy that will Spark a Recession, It's Uncertainty

  • Central bankers are having to contend with one of the most complex macroeconomic environments in decades and as a result, are having to develop policy on the fly, fueling uncertainty.

  • A persistent and clear predictable path of tightening would be preferable to ad-hoc, piecemeal, hot again, cold again, policy application, which is what could ultimately spark off a recession.

Nobel laureate in economics Paul Krugman posits that the largest short-term risk facing the U.S. economy is the U.S. Federal Reserve’s tightening policies as it battles with inflation.

In an interview with Bloomberg Radio, Krugman suggests that there is a possibility that the “Fed will overdo it (tightening of policies) and it will slam the brakes too hard”.

Interest-rate futures are also communicating investors expect policymakers will raise benchmark interest rates to 3.5% before early 2023, double their current target range of lies between 1.5% to 1.75%.

Krugman asked, “How much exactly do interest rates need to rise?” adding that policymakers themselves have no clear idea of an exact interest rate level that would stabilize the economy and put a lid on price pressures.

To be sure, policymakers are having to face off with the most complicated macroeconomic landscape in decades.

From supply chain snarls caused by rolling zero-Covid lockdowns in China, to the ongoing Russian invasion of Ukraine, keeping key commodities out of global markets, it’s understandable that policymakers aren’t going to get it right.

Whereas U.S. Federal Reserve Chairman Jerome Powell could argue that the economy would react to rate expectations in real time, the current level of unpredictability has meant that neither businesses nor the market know what to expect or how to prepare.

And while that has created greater volatility in asset markets, where they have been most damaging is in the real economy – companies don’t know what borrowing costs are going to look like and how demand will be affected, which means that hiring and planning are unpredictable as well, which creates a self-perpetuating feedback loop of uncertainty for policymakers.

Consumers and businesses don’t know what happens next and so they sit on the sidelines, policymakers see that things aren’t getting better and so they tighten but only on an ad-hoc piecemeal basis, which is ultimately what wreaks the most havoc on an economy – uncertainty.

To that end, Krugman’s contention is valid – it’s not so much that tightening will bring about a recession, it’s the uncertainty that inflation and tightening create that could cause one.

2. A week of relief for markets, but is it durable?

  • Weaker economic data has investors betting that central banks will be constrained in their ability to tighten policy, seeing an 11th hour rally in rate-sensitive tech stocks.

  • Investors may be better off taking some money off the table regularly as such sentiment-fueled relief rallies are unlikely to be durable.

The global financial markets saw some respite on Friday as it realizes its first weekly rally of the month. Worries about an impending recession are urging investors to reevaluate how belligerent central banks will be to quell soaring inflation.

Up-to-date economic data has proven to be insipid, seeing numerous traders curtailing their assumptions on how much the U.S. Federal Reserve will tighten its policies as economic growth slows.

Investors hope that lackluster economic data will rekindle animal spirits and that an economic slowdown could allay inflation as central banks will have lesser need to raise interest rates.

The benchmark S&P 500 chalked up a 6.4% gain last week while the tech-heavy Nasdaq Composite Index climbed 7.5%, its biggest weekly gain since March this year, with tech stocks being more sensitive to interest rates than other sectors.

Since tech companies tend to focus on growth instead of dividends, lower interest rates and a low-yield environment facilitate the risk-taking narrative, which favors tech stocks and other assets like cryptocurrencies.

Whether last week’s rally proves durable remains to be seen.

Markets continue to be whipsawed by conflicting economic data, central bank policy guidance and general uncertainty with respect to the global economic outlook.

3. Could the bottom come when the last Bitcoin Miner becomes a bear?

  • Bitcoin miners are traditionally "hodlers" who only sell the cryptocurrency when needed, but persistently low prices and leveraged miners are being pressured to sell to make ends meet.

  • High equipment and energy costs, coupled with leverage means that any rally in the benchmark cryptocurrency is likely to be short lived as miners are under pressure to generate revenue to keep up with costs.

Like the canary in the coal mine, Bitcoin miners, which are net “hodlers” of Bitcoin, have turned sellers, as they struggle with rising costs of energy, to keep operations afloat.

A persistent downturn in the cryptocurrency markets is ratcheting up the weight of a US$4 billion loan burden on Bitcoin miners who borrowed money to buy mining equipment.

With an increasing number of loans to Bitcoin miners now coming under strain, that stress and risk of default is spilling over to cryptocurrency lenders at the worst possible time.

Over the past several weeks, some of the biggest names in the crypto lending business, including Celsius Network, BlockFi and Babel Finance have either halted withdrawals or displayed stress at risk of insolvency.

Making matters worse, one of the largest cryptocurrency funds, Three Arrows Capital, is believed to be insolvent, and speaking with legal and financial advisors.

Three Arrows Capital is known to have borrowed heavily from a wide range of crypto lenders and if the fund is in default, could jeopardize the solvency of these companies, at a time when Bitcoin miners are also under stress from persistently low prices.

Pressure to sell Bitcoin from miners, to make ends meet, would mean that any rally in the benchmark cryptocurrency is likely to be short lived.

Listed cryptocurrency miners have already declared their Bitcoin sales for May and June to meet costs, raise liquidity, and to possibly deleverage.

And until such time that Bitcoin prices durably improve, miners are likely to err on the side of caution in favor of longevity over capital gains.

Meanwhile, privately held Bitcoin miners have sold large portions of their mining gains, as demonstrated from blockchain flows, to ensure sufficient funds to cover overheads, given their more restricted access to the capital markets.

Bitcoin has fallen by over 50% year-to-date amidst the hawkishness of the U.S. Federal Reserve’s interest rate hikes and its alleged role as a hedge against inflationary pressure has so far failed to materialize.

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