Hello there,

A fantastic Friday to you as markets across the board are painted in a sea of red, with little to stem the bleed.

In brief (TL:DR)

• U.S. stocks tumbled on Thursday with the Dow Jones Industrial Average (-2.42%), S&P 500 (-3.25%) and the Nasdaq Composite (-4.08%) all sharply lower as concerns over tighter policy gave way to recession worries.

• Asian stocks were mostly lower on Friday on fears of an economic downturn.

• Benchmark U.S. 10-year Treasury yields stabilized at 3.238% (yields fall when bond prices rise) down from the 3.4% they were pushing earlier.

• The dollar rebounded in Asian trading.

• Oil slipped with July 2022 contracts for WTI Crude Oil (Nymex) (-0.42%) at US$117.10 on recession fears.

• Gold inched lower with August 2022 contracts for Gold (Comex) (-0.11%) at US$1,847.80 as the dollar gained.

• Bitcoin (-7.92%) tumbled to US$20,617, on renewed selling pressures and growing concern about the interconnectedness and depths of the fallout from a possible insolvency of cryptocurrency fund Three Arrows Capital as well as the Celsius Network.

In today's issue...

1. No Easy Outs for Stock Traders

2. Investors in Chinese Assets May Need to take a Long-Term View

3. Cryptocurrency Fund Three Arrows Capital took One Arrow too Many

Market Overview

Global stocks continue to be hammered, squeezed on the one side by tighter monetary policy that is threatening to derail risk appetite, while concerns over a possible recession for the U.S. loom on the horizon.

Meanwhile, all is not well in China, where consumer sentiment is being sapped by rolling, repeated and unpredictable lockdowns and total retail sales falling for a third consecutive month in May, with supply chains and incomes impacted by the zero-Covid policy.

Japanese bond yields are soaring despite efforts by the Bank of Japan to keep soaking up Japanese sovereign debt, with growing concerns that a major crisis could ensue.

Asian markets continued to slide on Friday with Tokyo's Nikkei 225 (-1.65%), Seoul's Kospi Index (-1.05%), and Sydney’s ASX 200 (-2.14%) down in the morning trading session, while and Hong Kong's Hang Seng Index (+0.34%) was up marginally.

1. No Easy Outs for Stock Traders

• Yesterday, a senior Fed official called for rate hikes to a level which stunt economic growth by the end of the year, unperturbed by what that would do to the labor market.

• Investors therefore should keep a keen eye on Friday’s U.S. labor report, which has routinely outperformed economist estimates and could embolden hawks on the Fed.

Given how U.S. Federal Reserve policy has taken on an outsize influence on the markets, more traders are throwing in the towel and just selling everything.

Part of the reason of course is right up till this past Wednesday’s Federal Open Market Committee meeting, policy directions were relatively certain, with the central bank having made clear that the June hike would likely be 50-basis-points, as would July.

But the fastest pace of inflation in four decades has meant that this Fed deployed its “nimbleness” in policy construction and there is less certainty about policy pathways ahead, even in times of stress.

With inflation still running white hot and odds of a U.S. recession rising fast, traders trying to figure out what happens next are finding it impossible.

Almost nothing in the markets was spared, bonds, stocks, cryptocurrencies, were all hammered.

Making markets even more uncertain, U.S. Federal Reserve Chairman Jerome Powell provided no forward guidance on next month’s meeting, which could deliver a 50-basis-point or a 75-basis-point rate hike.

Given how even the Fed is uncertain as to what the next inflation print is likely to be, it can’t meaningfully plot policy either, but Powell and his colleagues have made clear that their focus is on rising prices.

Adding to the uncertainty is the Fed’s sudden pivot to focus on headline inflation numbers which include volatile food and fuel figures, although the central bank has typically always preferred measures which strip out energy and food costs to zoom in on more persistent sources of price pressures.

All of which mean that investors could end up on the wrong side of trades more often than they expect because even the Fed doesn’t know.

2. Investors in Chinese Assets May Need to take a Long-Term View

• When the price of crude blasts past US$120, it’s a big deal, and not just for consumers, but for every area of the economy.

• It’s entirely possible that as oil prices continue to rise, it could be a harbinger of the economic pain that is to come.

Despite no shortage of rhetoric from Beijing that it intends to support the Chinese economy and proactive measures to lift the debilitating crackdown on key sectors such as real estate and technology, there are signs that a quick rebound is not on the cards for the country.

After years of interfering with its economy and arbitrary policy decisions that have seen entire sectors become non-profits overnight, rolling zero-Covid lockdowns have now fatigued Chinese consumers to the extent that they are no longer shopping.

According to China’s No.2 online retailer JD.com, there are worrying signs that shoppers are reluctant to reopen their wallets even as major cities recover from start-stop lockdowns and consumer spending may take a lot longer to recover.

In an interview with Bloomberg Television, JD.com CEO Xin Lijun noted that rolling lockdowns have caused a fundamental shift in how people spend their money, with a pullback in discretionary spending continuing even when lockdowns were lifted.

According to Xin,

“The outbreak this year has completely cut off the supply chains both internationally and domestic, and this has indeed impacted people’s livelihoods, which will probably take longer to recover.”

For months, retailers have been buffeted by Beijing’s harsh lockdowns in an attempt to control fresh outbreaks of the coronavirus, paralyzing factory output and undermining consumer spending.

Even as these lockdowns have been lifted, weary Chinese have stocked up primarily on essentials in anticipation of the next round of restrictions, instead of spending on discretionary items, meaning that the odds of China achieving growth targets becomes even less likely.

And even as global investors have started to pour back into Chinese assets, major drivers of market moves, Chinese retail investors, have shied away from the stock market.

Even as Chinese President Xi Jinping confirms an unprecedented third term in office, things may get worse before they get better.

Many of the moves to relax measures may be temporary, to ensure a smooth leadership transition and Xi has repeatedly doubled down on his economically debilitating zero-Covid lockdowns to such a point that he can’t back away without losing credibility and face.

In May, Chinese retail sales shrank for a third straight month, according to official data and Xin reports that demand has been growing for essentials such as rice and oil, as well as appliances to store them in like refrigerators, while entertainment and fashion have not seen an uptick in demand.

Making matters even more complex for persistent China bulls is that zero-Covid policies including testing and travel restrictions, with varying degrees of aggressiveness, continue to be applied

inconsistently as Communist Party apparatchiks fall over each other to demonstrate fealty to the Party and their leader, Xi.

3. Cryptocurrency Fund Three Arrows Capital took One Arrow too Many

• It is now coming to light that Tether may actually have some real dollars, outside of the commercial paper, Treasuries, precious metals and cryptocurrencies that it uses to back USDT, in a small Bahamas bank called Capital Union.

• In an interview with the Financial Times earlier this month, Tether’s Chief Technology Officer Paolo Ardoino said that its most liquid reserves, cash deposits, were held at two banks in the Bahamas and it’s been said that Capital Union is one of those banks.

A vague tweet by a founder, swirling rumors of insolvency, documented evidence of ghosting, are just the latest development in the soap opera that is cryptocurrency trading with Three Arrows Capital, an influential trading firm thought to be insolvent.

Classifying Three Arrows Capital, or 3AC as it’s better known, is no mean feat.

On the one hand it isn’t a regulated fund, but it does perform treasury management for crypto clients. It’s a venture capital investor in a variety of projects, but it is also said to manage a substantial portion of its own money.

Which is why social media has struggled to categorize the multifaceted 3AC and why its possible insolvency is such a big deal.

Thought to be among the biggest holders of cryptocurrency in the world, the past few days have revealed forced liquidations and margin calls at 3AC, putting downwards pressure on an already embattled cryptocurrency market having to deal with rising interest rates.

As recently as March this year, data from blockchain analytics firm Nansen.ai suggested that 3AC may have been managing as much as US$10 billion in assets.

Of greater concern is that much of those assets were treasury assets.

Many protocols and projects which have raised millions of dollars from venture capitalists and other investors also need to manage their own treasury and instead of leaving their cryptocurrencies lying fallow, are said to have handed it to 3AC for management.

In some cases an 8% annual return was guaranteed and protocols would park their funds with 3AC, believing it to be safe because of the firm’s reputation in the market.

To that end, 3AC isn’t exactly like the overly-leveraged implosion of Archegos Capital Management because in that case, it was mainly Bill Hwang’s money from his family office.

According to allegations, 3AC took copious amounts of leverage betting big on cryptocurrencies at a time when the market was sinking rapidly because of macro factors beyond the control of anyone and sparking cascading liquidations.

3AC would have already been reeling from the implosion of TerraUSD and its sister token Luna, to which it had a large exposure to, where it had invested US$1 billion in a token saler earlier this year, a stake now estimated to be worth just over US$600.

Recent attention around 3AC however has come around staked Ether or stETH, a token offered by a decentralized finance app called Lido Finance that had widely been used in the market as the “equivalent” of regular Ether.

The stETH token is meant to be redeemable for Ether after a planned upgrade of the Ethereum network, with Lido Finance offering depositors an interest rate to lock up their Ether with the platform, but receiving stETH which they can then lend or trade on other platforms while waiting for the Ethereum upgrade.

But selling pressure caused stETH to depeg from its presumed 1:1 relationship with regular Ether, creating problems for users that use stETH in loans or other investments.

According to Nansen data, 3AC started actively withdrawing stETH from decentralized platforms as early as last month taking the haircut by swapping stETH for Ether in what appeared to be a warning of liquidity issues.

Complicating matters, there has been no shortage of allegations that 3AC is now ghosting its creditors, including protocols that had entrusted their treasuries to the firm for management.