Hello there,

A wonderful Wednesday to you as stocks and bonds get walloped on the prospect of the U.S. Federal Reserve ratcheting up its balance sheet runoff as soon as May.

In brief (TL:DR)

• U.S. stocks closed lower on Tuesday with the Dow Jones Industrial Average (-0.80%), the S&P 500 (-1.26%) and the Nasdaq Composite (-2.26%) following a drop in Wall Street shares led by the technology sector.

• Asian stocks declined Wednesday on the prospect of a swift reduction in the U.S. Federal Reserve’s debt holdings as part of a stepped up campaign of monetary tightening to tackle high inflation.

• Benchmark U.S. 10-year Treasury yields advanced six basis points to 2.61% (yields rise when bond prices fall) on the prospect of sharp U.S. Federal Reserve interest-rate hikes to fight inflation.

• The dollar was near a three-week peak.

• Oil dipped with May 2022 contracts for WTI Crude Oil (Nymex) (-0.18%) at US$101.78 on continued concern over demand out of China.

• Gold edged lower with June 2022 contracts for Gold (Comex) (-0.09%) at US$1,925.80.

• Bitcoin (-2.81%) fell to US$45,292 in line with the broader fall in stocks and other risk assets as the U.S. Federal Reserve threatens to runoff its balance sheet at a faster pace.

In today's issue...

1. The Fed is Running, Running and Running, Running its Balance Sheet

2. Inflation May be Coming From Unexpected Places

3. Anatomy of NFT Insider Trading

Market Overview

Stocks and bonds declined Wednesday on the prospect of a swift reduction in the U.S. Federal Reserve’s debt holdings as part of a stepped up campaign of monetary tightening to tackle high inflation.

Markets signal a half-point Fed rate increase is on the cards at next month’s policy meeting. At the same time, price pressures show little sign of abating as war stokes already elevated raw-material costs.

Meanwhile, the latest data from China indicated that activity in its services industry contracted in March amid mobility curbs to stem a Covid-19 outbreak.

Asian markets fell Wednesday with Seoul's Kospi Index (-0.92%), Tokyo's Nikkei 225 (-1.89%), Sydney’s ASX 200 (-0.74%) and Hong Kong's Hang Seng Index (-1.85%) were all down in the morning trading session.

1. The Fed is Running, Running and Running, Running its Balance Sheet

• With inflation in the U.S. running at a four-decade high, there is growing pressure to do more on rising costs of living for Americans.

• By running down its US$9 trillion balance sheet of U.S. Treasuries and mortgage-backed securities, yields could surge significantly, making risk assets less attractive in comparison.

Investors who were hoping that the U.S. Federal Reserve would keep policy tightening on an even pace were perhaps caught off guard by comments from the central bank’s most hawkish policymaker yet, soon-to-be appointed Vice Chairman Lael Brainard.

To be fair, had Biden nominated Brainard to have helmed the Fed, instead of the steady and cooler hand of Chairman Jerome Powell, the rate hike in March could easily have been 0.50%.

But with inflation in the U.S. running at a four-decade high, there is growing pressure to do more on rising costs of living for Americans.

In a virtual speech to the Minneapolis Federal Reserve Bank, Brainard noted that the rate-setting Federal Open Market Committee (FOMC) will,

“Continue tightening monetary policy methodically through a series of interest rate increases and by starting to reduce the balance sheet at a rapid pace as soon as our May meeting.”

But Brainard does not set policy by diktat and sits on an FOMC with both doves and hawks, who will jointly come to terms of where U.S. monetary policy ought to head next.

Shares and other risk assets naturally tumbled in the wake of her comments as most analysts had expected the Fed to start reducing its balance sheet towards the end of this year.

By running down its US$9 trillion balance sheet of U.S. Treasuries and mortgage-backed securities, yields could surge significantly, making risk assets less attractive in comparison.

Markets could be in for a bout of volatility as investors and analysts will pour through the minutes of the Fed’s last meeting on March 15-16, to gain an insight into the thinking of policymakers and whether they could get more aggressive on rate hikes and tightening.

Investors were blindsided by Brainard’s comments because if the Fed were to start aggressively running off its balance sheet starting in May, it would be over and above the expected increases in the policy rate and create a backdrop of far more aggressive tightening.

But sometimes the Fed uses talking points to influence policy, without necessarily actioning on them and Brainard noted,

“On the other side, I am attentive to signals from the yield curve at different horizons and from other data that might suggest increased downside risks to activity.”

The yield curve has inverted of late (where near-term U.S. Treasuries yield more than those dated further out), suggesting that market participants are anticipating challenges to the economy, something which policymakers remain cognizant of.

While the market appears to have started pricing in a rate hike of 0.50%, a more aggressive runoff as soon as May could take investors by surprise.

2. Inflation May be Coming From Unexpected Places

• The disastrous zero-Covid policies of Chinese President Xi Jinping and his sycophantic apparatchiks have frustrated whole urban populations as cities were plunged into debilitating lockdowns.

• Strict lockdowns have meant that deliveries of fertilizers ahead of key planting seasons have been delayed and missing the window to plant could impact agricultural output down the line.

While the Russian invasion of Ukraine is a clear contributor to already high levels of inflation globally, another source of price pressures could be coming from somewhere few investors are paying attention to – China.

The disastrous zero-Covid policies of Chinese President Xi Jinping and his sycophantic apparatchiks have frustrated whole urban populations as cities were plunged into debilitating lockdowns, but now these same lockdowns are rippling through to the countryside, where food is grown.

Covid lockdowns are exacerbating already serious shortages of fertilizer and seeds wrought by the Russian invasion of Ukraine, stymying the ability of labor to work the land and could leave China’s agricultural land fallow as the crucial spring planting season is missed.

With three weeks to go before farmers in Jilin are due to start planting, official Chinese data suggests that around one third of farmers did not have enough fertilizer.

Yet there are few signs that Beijing is prepared to reverse course on its zero-Covid policy, as municipal governments fall over each other to show how loyal they are to President Xi’s cause, in a race to the bottom.

Strict lockdowns have meant that deliveries of fertilizers ahead of key planting seasons have been delayed and missing the window to plant could impact agricultural output down the line.

Fertilizer factories in China are also said to be struggling, with many experiencing difficulty shipping to customers and securing raw materials, with many townships refusing to let in trucks from other regions, gumming up the supply chain crucial to agriculture.

According to official Chinese data, as many as a third of farmers in the northeastern provinces of Jilin, Liaoning and Heilongjiang, have insufficient agricultural inputs after authorities sealed off villages to ward off the pandemic.

Combined, Jilin, Liaoning and Heilongjiang make up over a fifth of China’s grain production and a drop in crops that need to be planted in spring, such as rice and corn, could dramatically undermine Beijing’s decades-long goal to achieve self-sufficiency in staple foods, forcing it to increase imports and adding to global food price inflation.

3. Anatomy of NFT Insider Trading

• Launched in January by two anonymous co-founders, who go by the nom de guerre Zodd and Guts, LooksRare was intended as an alternative to leading NFT marketplace OpenSea, at the height of the NFT boom.

• But the only “alternative” that LooksRare is offering is a different platform for wash trading as about 95% of the US$18 billion of trading volume according to CryptoSlam is from NFT owners trading with themselves.

In traditional financial markets, rules exist to protect investors from market manipulation through self-dealing, but in the world of cryptocurrencies, no such rules exist. These are their stories. (Cue Law & Order “dum dum” sound).

To understand how “crypto bros” can make an NFT or non-fungible token look a lot rarer and more actively traded than it actually is, take a look at the aptly named “LooksRare” platform that has quickly become the leading NFT marketplace by trading volume.

LooksRare is aptly named because many of the NFTs being traded on its platform really just look rare, because a closer examination of blockchain activity reveals that most of the trading activity is actually from users selling the tokens to themselves to earn rewards in the form of more LooksRare tokens.

Launched in January by two anonymous co-founders, who go by the nom de guerre Zodd and Guts, LooksRare was intended as an alternative to leading NFT marketplace OpenSea, at the height of the NFT boom.

But the only “alternative” that LooksRare is offering is a different platform for wash trading as about 95% of the US$18 billion of trading volume according to CryptoSlam is from NFT owners trading with themselves.

These wash trades serve several purposes, LooksRare incentivizes NFT owners to trade with themselves and receive tokens in return, while the platform receives fees generated by each transaction.

In return, LooksRare gets a lot more trading volume than actually occurs.

The side effect of all of this is that LooksRare is masking a rapidly cooling NFT market.

Total sales on OpenSea have declined every month since January, according to data from Dune Analytics and the site’s sales volume is down 67% in the last 30 days according to data from DappRadar.

To be fair, earning tokens for performing tasks is not new and is one of the prominent aspects of DeFi, where the provision of liquidity is rewarded with platform tokens.

But the introduction of token incentives into NFTs is a relatively new invention, with Rarible among those NFT platforms to pioneer the concept last year.

Unlike traditional financial assets such as stocks and bonds, wash trading is not illegal in the cryptocurrency markets, but if it becomes a persistent enough problem, could invite greater scrutiny from regulators.

For now, LooksRare really is just that, something that looks rare.