Hello there, A magnificent Monday to you as markets muddle into another week with conflicting signals from everywhere. In brief (TL:DR)

• U.S. stocks were a mixed bag at the close on Friday with the Dow Jones Industrial Average (-0.56%), tumbling on concerns over weaker-than-expected retail sales while the S&P 500 (+0.08%) and the Nasdaq Composite (+0.59%) saw a last minute rebound in tech stocks.

• Asian stocks were mixed Monday as traders weighed policy easing by China’s central bank and data highlighting the challenges facing the nation’s economy.

• Benchmark U.S. 10-year Treasury yields advanced eight basis points to 1.78% Friday (yields rise when bond prices fall) with traders betting that yields could top off as high as 2.5% on concerns over interest rate hikes.

• The dollar inched higher.

• Oil extended its rally with February 2022 contracts for WTI Crude Oil (Nymex) (+0.47%) at US$84.21 on possible supply constraints.

• Gold was little changed with February 2022 contracts for Gold (Comex) (+0.02%) at US$1,816.90.

• Bitcoin (-0.34%) was at US$42,941 as activity in the options market suggests that bitcoin could be consolidating to push higher.

In today's issue...

1. European Bank Stocks Back in the Limelight

2. How Could China’s Lumbering Economy Affect U.S. Rates?

3. What does the Bitcoin Options Market Reveal about where prices are heading next?

Market Overview

Ah the smell of another manic Monday as markets appear just as confused as policymakers over what happens next.

The start of the earnings season has put the focus on corporate profits and whether they can help arrest a retreat in global equities led in part by a slide in U.S. technology shares, even as a slowdown in China may color the appetite for the aggressiveness of policy tightening by the U.S. Federal Reserve.

A real-estate slump and power shortages have contributed to the slowdown in Chinese expansion. The second-largest economy is also grappling with partial shutdowns to stem the spread of Covid-19.

In Asia, markets were mixed Monday with Tokyo's Nikkei 225 (+0.69%) and Sydney’s ASX 200 (+0.07%) up, while Seoul's Kospi Index (-1.21%) and Hong Kong's Hang Seng (-0.68%) were lower in the morning trading session.

1. European Bank Stocks Back in the Limelight

• A potentially tightening U.S. Federal Reserve, which looks set to hike interest rates by March this year, has since seen European bank stocks return to the spotlight.

• Major central banks are preparing markets for tighter monetary policy to combat inflation and a surge in bond yields will help banks lend more profitably.

In the more than a decade past the 2008 Financial Crisis, European bank stocks languished as tighter regulation ate at profits and many had to hive off their investment banking divisions as regulators tightened the screw on the industry. It also didn’t help that European banks took write downs on their exposure to mortgage-backed securities, were issued hefty fines for money laundering and whiplashed by sovereign debt issues from Greece to Spain. But a potentially tightening U.S. Federal Reserve, which looks set to hike interest rates by March this year, has since seen European bank stocks return to the spotlight. European banks are the best-performing stocks in what has been a choppy year for trading, with the Stoxx Europe 600 Index up some 10% in the nine straight days to start the year before taking a breather last Friday, their longest winning streak since 2018 and the best January on record. As any momentum trader will attest, the best time to get in on an asset is when its fortunes have turned, instead of trying to catch the highest high or the lowest low. Major central banks are preparing markets for tighter monetary policy to combat inflation and a surge in bond yields will help banks lend more profitably. A broad economic recovery from the pandemic will also lead to more borrowing by businesses and consumers and will beef up earnings for banks. Low to negative bond yields, relentless regulatory pressure and failed turnarounds have for years seen the stocks of some of Europe’s most storied lenders lag the general market, with the Stoxx 600 Banks Index losing 45% in the decade through 2020, while broader indices gained by the same amount. European bank stocks, which are trading at record low valuations, are looking to make up for their lost decade. Whether or not investors should dip their toes in these waters however remains debatable. While European banks are starting the year with attractive valuations, high distribution yields from dividends and share buybacks and a strong earnings dynamic, a lot depends on two major factors – technology and interest rates. Unlike in the U.S., Europe has been relatively more open to digital banking startups and fintechs, which have consistently eaten away at the market share of legacy banks. Some of the world’s biggest digital banks and payment services companies are now founded in Europe. It’s also unclear if the Eurozone can afford for interest rates to rise excessively, given the considerable debt load that many European Union members, outside of Germany, service. Unlike the U.S., sovereign debt in the E.U. is very much a national, as opposed to a continental affair. Some investors are taking advantage of the uptick to offload shares acquired earlier. Last week, Cerberus Capital Management sold about US$513.2 million worth of shares in Deutsche Bank AG (-2.02%) and Commerzbank AG (-1.51%), reducing stakes it took in 2017. If the “smart money” isn’t entirely sold on this recent European bank rally, should retail investors be?

2. How Could China's Lumbering Economy Affect U.S. Rates?

• China is going through the same economic issues that will nonetheless provide the Fed food for thought as it embarks on the “normalization” of monetary policy.

• If 2015 provides any guide, it’s that while the Fed is likely to stick to its interest rate hike, it may not be as large or as aggressive as traders are starting to price in.

A review of U.S. Federal Reserve policy meeting minutes from 2015 and 2016 show that when then policymakers were considering hiking rates, in the aftermath of the 2008 Financial Crisis, they wavered because China was set for a slowdown. While the circumstances back in 2015 are arguably dissimilar to the present, noticeably inflation was muted back then, China is going through the same economic issues that will nonetheless provide the Fed food for thought as it embarks on the “normalization” of monetary policy. Still reeling from the economic pain of its own design, China’s economy is now bracing for a hit from partial shutdowns as authorities try yet again to reign in the spread of Covid-19. Chinese GDP data is due out later today and will likely show the impact of the real estate downturn in the fourth quarter of 2021, as well as electricity shortages denting manufacturing numbers. Growth in the world’s second largest economy may have slowed to its weakest since the pandemic first hit, even before accounting for the impact of the Omicron variant. Beijing’s zero-tolerance approach to the pandemic through lockdowns and quarantines is putting a cap on consumer spending and factory shutdowns are putting a dent on incomes and sentiment ahead of China’s peak spending season for the Lunar New Year. Goldman Sachs (-2.52%) is already cutting China’s growth forecast for this year to 4.3%, one of the lowest levels since reforms to open up the economy first began. That gloomy outlook for the Chinese economy is fueling speculation that Beijing will have no choice but to increase monetary stimulus, with officials already paving the way with more dovish signals and posturing. The reserve requirement ratio for banks has been cut and behind the scenes, lenders are being “encouraged” to make funds more freely available. Some traders are betting that an interest rate cut could come as soon as today, as the People’s Bank of China looks to front-load its support of the economy, putting China at odds with major economies like the U.S. which looks set to tighten. If 2015 provides any guide, it’s that while the Fed is likely to stick to its interest rate hike, it may not be as large or as aggressive as traders are starting to price in.

3. What does the Bitcoin Options Market Reveal about where prices are heading next?

• With bitcoin appearing to have stabilized, some investors will be wondering if now isn’t the time to wade back into cryptocurrency waters, especially if more upside is ahead.

• Nevertheless, the options market, which is a good indicator of where traders expect bitcoin and other cryptocurrencies to head in the near-term future, should provide some comfort for bulls.

Tarot cards, tea leaves and goat entrails – there’s no shortage of methodologies (of varying efficacy) to attempt to explain or (gasp) predict the future price action for bitcoin. But investors searching for clues as to where the bellwether cryptocurrency may be headed next might want to set down their goat for minute as movements in the options market appear to suggest that the bearish turn for bitcoin may soon be in the rearview mirror. After dipping below US$40,000 for the first time since last September and off almost 40% from its all-time-high recorded in November, bitcoin appears to have maintained composure above that important level of support. With bitcoin appearing to have stabilized, some investors will be wondering if now isn’t the time to wade back into cryptocurrency waters, especially if more upside is ahead. Difference in implied volatility of bullish and bearish bets has recently dropped from double-digits to almost zero, revealing a decrease in demand for bearish put options (the right to sell at a specific price) and an increase for bullish call options (the right to buy at a specific price). Given that more investors are “hodling” bitcoin for the long-term, the support at US$40,000 lends heft to the theory that the cryptocurrency has bottomed out, providing an opportunity for new entrants to go long on the famously volatile asset. There are however short to medium term limits on the upside of bitcoin, especially since the U.S. Federal Reserve has taken a hawkish turn, with the prospect of interest rate hikes potentially curbing appetite for risk assets. Institutional capital also continues to flow into the cryptocurrency space and the circumstances appear to be different from the 2017-2018 period, which ushered in a two-year “Crypto Winter.” Because bitcoin and cryptocurrencies have recently demonstrated strong correlations with high-growth tech stocks, some investors are waiting to see equities take a turn for the better before plunging into digital assets. But correlations between cryptocurrencies and other assets have never been static, and the limited data and relative immaturity of the nascent asset class has meant that cryptocurrencies have not shown consistently unbroken correlations, making it even more complex for investors to figure out what happens next. Nevertheless, the options market, which is a good indicator of where traders expect bitcoin and other cryptocurrencies to head in the near-term future, should provide some comfort for bulls.