Hello there,

A wonderful Wednesday to you as markets wind down even lower after the U.S. long weekend with Treasury yields soaring to their highest in 2 years.

In brief (TL:DR)

• U.S. stocks closed Tuesday with the Dow Jones Industrial Average (-1.51%), the S&P 500 (-1.84%) and the Nasdaq Composite (-2.60%) with U.S. Treasuries in a sharp selloff seeing yields spike dramatically to their highest in 2 years.

• Asian stocks mostly fell Wednesday following a Wall Street selloff in the wake of a surge in Treasury yields.

• Benchmark U.S. 10-year Treasury yields advanced one basis point to 1.88% (yields rise when bond prices fall).

• The dollar edged lower.

• Oil extended a rally with February 2022 contracts for WTI Crude Oil (Nymex) (+1.83%) at US$86.99 after a pipeline running from Iraq to Turkey was hit by an explosion, taking out crucial supply.

• Gold was little changed with February 2022 contracts for Gold (Comex) (+0.02%) at US$1,812.70.

• Bitcoin (+0.21%) was at US$42,376 with the benchmark cryptocurrency trading flat and on diminished volumes, holding its own despite the sharp selloff in risk assets.

In today's issue...

1. Microsoft to Buy Activision in Tip to the Metaverse

2. Is the Selloff in U.S. Treasuries Overdone?

3. U.S. Banks Are Making Hay While the Crypto Sun Shines

Market Overview

Global equities have had a volatile start to the year, hurt by a more hawkish Fed stance, economic disruptions from the omicron virus strain and risks to company profits due to rising costs.

Higher bond yields are forcing investors to rethink valuations across a range of assets, especially those that had had a strong rally during the pandemic, including cryptocurrencies and tech stocks.

In China, where policy is diverging from the U.S., the central bank pledged to use more monetary policy tools to aid the economy and ease credit stress amid a real-estate slump leading to an index of Chinese property stocks rallying strongly.

In Asia, markets were mostly lower with Tokyo's Nikkei 225 (-2.19%), Sydney’s ASX 200 (-1.06%) and Seoul's Kospi Index (-0.84%) down, while Hong Kong's Hang Seng (+0.02%) was slightly up in response to sharply rising Treasury yields.

1. Microsoft to Buy Activision in Tip to the Metaverse

• Microsoft’s (-2.43%) bet on the metaverse comes in – through a deal to buy Activision Blizzard (+25.88%) for US$68.7 billion.

• Nonetheless, Microsoft’s acquisition of Activision Blizzard will help the software giant expand its own offerings for the Xbox console and push into the fast-growing markets for mobile gaming and the metaverse.

To anyone yet unsure of what the metaverse is, Hollywood has provided some glimpses in the past – the best impression arguably being the movie Ready Player One.

With more of our lives lived virtually than ever before (no thanks to the pandemic), technologists are predicting that our world will become increasingly digital and that the metaverse is where everything will happen.

Which is where Microsoft’s bet on the metaverse comes in – through a deal to buy Activision Blizzard for US$68.7 billion.

Every gamer will know the Activision Blizzard name well, with real-time strategy classics such as World of Warcraft and the seminal first-person shooter Call of Duty.

But unfortunately, Activision Blizzard has been making headlines recently not for its games, but over allegations of sexual misconduct and discrimination.

Nonetheless, Microsoft’s acquisition of Activision Blizzard will help the software giant expand its own offerings for the Xbox console and push into the fast-growing markets for mobile gaming and the metaverse.

In a note to employees regarding the acquisition, Microsoft CEO Satya Nadella wrote,

“Gaming has been key to Microsoft since our earliest days as a company. Today, it’s the largest and fastest-growing form of entertainment, and as the digital and physical worlds come together, it will play a critical role in the development of metaverse platforms.”

But the metaverse may be the only place these two companies get to be married as the deal will likely face tough regulatory scrutiny in the U.S., where big tech is being probed by regulators for their reach and influence.

The prospect of Activision Blizzard titles receiving more access to Microsoft’s Xbox, to the exclusion of other publishers could also be an issue.

Microsoft’s bid for Activision Blizzard represents a 45% premium over the firm’s closing price last Friday, but is a bargain compared with the stock’s performance in the first half of last year before a sexual bias lawsuit plunged the company into crisis.

The scandal is just one of the many challenges facing Activision Blizzard, which has struggled to adapt to the end of a pandemic-fueled vide game boom.

Last November, Activision Blizzard delayed two hotly anticipated games and provided sales forecast for the fourth quarter far short of Wall Street expectations.

It’s blockbuster title Call of Duty, with the massively popular Warzone multiplayer version of the game, has faced heaps of criticism over rampant hackers, cheaters, and poor gameplay.

In 2020, Call of Duty accounted for as much as 55% of the Activision division of the firm and is arguably the most important business there.

A report in 2021 by Baird analysts also suggests that online searches for Call of Duty and World of Warcraft were down 32% and 44% respectively from 2020, marking a significant decline.

2. Is the Selloff in U.S. Treasuries Overdone?

• U.S. Treasury yields have jumped to their highest in two years after traders returned from the Martin Luther King Jr. long weekend, with markets for the first time fully pricing in the prospect of four interest rate hikes from the Fed this year.

• Given the lack of certainty, investors are playing into their worst fears, with doomsday rate callers like JPMorgan Chase CEO Jamie Dimon scaremongering and suggesting that the Fed could hike rates by six or seven times this year.

With U.S. Treasury yields soaring to unthinkable levels, investors are ratcheting up bets that monetary tightening by the U.S. Federal Reserve have reignited a selloff in Treasuries and pushed U.S. equities to multi-month lows.

U.S. Treasury yields have jumped to their highest in two years after traders returned from the Martin Luther King Jr. long weekend, with markets for the first time fully pricing in the prospect of four interest rate hikes from the Fed this year.

But can the Fed hike that much that fast?

There are some who believe that the Fed won’t be so hasty to up the ante on rates, with Fitch Ratings posting in a note as recently as 11 January 2022 that it expects the central bank to raise rates only twice this year, and a further four times next year to take the Fed funds rate (upper bound) to just 1.75% by the end of 2023.

Fitch Ratings has a rate outlook that is far more sanguine than what investors have priced into the markets currently, believing that the Fed will only hike rates in June and September, as the omicron variant may delay maximum employment ahead of the March meeting.

There may be some sense to that argument.

In December’s job data, the rate of job creation fell by over 50%, even though the unemployment level declined to 3.9%.

Unemployment in minority communities including African American and Latino also increased, suggesting that the job recovery is exacerbating inequalities already present in the United States prior to the pandemic.

Given the lack of certainty, investors are playing into their worst fears, with doomsday rate callers like JPMorgan Chase CEO Jamie Dimon scaremongering and suggesting that the Fed could hike rates by six or seven times this year.

That seems unlikely.

For starters, language by U.S. Federal Reserve Chairman Jerome Powell at his Senate confirmation hearing seems to suggest a more even keel that acknowledges the ill effects of inflation, but also recognizes the importance of economic growth.

And while there are more Fed voices concerned over inflation, members of the powerful Federal Open Market Committee haven’t all turned into hawks overnight, with concern lingering that over-tightening could hurt the job market that has recently shown signs of some weakness.

Right now markets are pricing in their worst fears and investors will need to gird themselves for greater volatility until rate clarity is set – the most likely outcome though is something in between – a Goldilocks tightening if you will, sufficient to make evident the Fed isn’t doing nothing on inflation, but not so much as to cause the markets to crash.

3. U.S. Banks Are Making Hay While the Crypto Sun Shines

• While hedge funds and other large institutional investors with significant latitude in their investment decisions were first to take the plunge, some of the most storied financial institutions are now looking to see how they can get in on a piece of the action.

• Nonetheless, the recent slide in cryptocurrency prices may provide the perfect opportunity for financial institutions to tool up as regulators get ready to lay down more comprehensive measures to govern the sector that has developed a reputation for being the Wild West.

With comprehensive regulation of cryptocurrencies some time away, some of Wall Street’s biggest names are plunging headfirst into the nascent digital asset class and figuring out the rules as they go along.

While hedge funds and other large institutional investors with significant latitude in their investment decisions were first to take the plunge, some of the most storied financial institutions are now looking to see how they can get in on a piece of the action.

Bank of New York Mellon (BNY Mellon) (-1.12%) recently said that digital assets could create a meaningful source of revenue as soon as next year, according to CFO Emily Portnoy.

BNY Mellon is collaborating with Fireblocks, a cryptocurrency custodian and unicorn fintech that has the potential to enable financial institutions to store, move and issue cryptocurrencies.

Although regulatory uncertainty surrounding cryptocurrencies is for now keeping BNY Mellon on the sidelines, there is some optimism clarity could come sooner than expected.

In an interview with Bloomberg, Portnoy said,

“There are proposals in front of the Securities and Exchange Commission that haven’t yet been approved on whether ETFs can actually hold digital assets directly versus futures.”

But Portney believes that regulatory clarity regarding physically-backed bitcoin ETFs could come as soon as the first half of this year.

Although the first U.S. bitcoin-adjacent ETF was launched last year to much fanfare – the Proshares Bitcoin Strategy ETF – flows into the product have declined alongside the fall in cryptocurrency prices in general, following prospects of tighter monetary policy.

The SEC has so far rejected calls to allow a pureplay bitcoin ETF that holds actual bitcoin, alleging that the proposals received so far fail to meet the requirements to prevent fraudulent and manipulative practices.

Nonetheless, the recent slide in cryptocurrency prices may provide the perfect opportunity for financial institutions to tool up as regulators get ready to lay down more comprehensive measures to govern the sector that has developed a reputation for being the Wild West.

Investors ultimately want regulatory clarity and certainty when the make their investments.

Portnoy noted that although digital assets won’t be a meaningful contributor to revenue until next year or 2024, she made clear that her bank was “leading the charge” in innovation in the space.