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Daily Analysis 22 March 2022 (10-Minute Read)

Hello there,

A terrific Tuesday to you as markets finally take a turn for the worse on U.S. Federal Reserve Chairman Jerome Powell's hawkish tone at a speech before the National Association for Business Economics yesterday.

In brief (TL:DR)

  • U.S. stocks closed lower on Monday with the Dow Jones Industrial Average (-0.58%), the S&P 500 (-0.04%) and the Nasdaq Composite (-0.40%) all down on the Fed's commitment to its hawkish pivot to reign in inflation.

  • Asian stocks pushed higher, weathering the volatility.

  • Benchmark U.S. 10-year Treasury rose four basis points to 2.33% (yields rise when bond prices fall) on concerns of more aggressive central bank rate hikes.

  • The dollar advanced.

  • Oil extended a rally with April 2022 contracts for WTI Crude Oil (Nymex) (+2.43%) at US$114.85 with Russia’s war in Ukraine nearing the one-month mark and no conclusion in sight continuing to put pressure on prices.

  • Gold was higher with April 2022 contracts for Gold (Comex) (+0.17%) at US$1,938.00.

  • Bitcoin (-0.17%) fell to US$41,159, in line with other risk assets as Powell's pivot to more hawkish language dampened appetite for the benchmark cryptocurrency.


In today's issue...

  1. China 737 Crash Couldn’t Have Come at a Worse Time for Boeing

  2. Beijing Bolsters its Dry Powder to Spend for Later

  3. Cryptocurrencies Get their Over-the-Counter Moment


Market Overview

U.S. Federal Reserve Chairman Jerome Powell said the central bank is prepared to raise interest rates by a half percentage-point at the next policy meeting if needed after it hiked by a quarter-point last week and signaled six more such moves this year.

The trajectory of bonds is a focal point for investors fretting about a growth slowdown or even a recession, and the flattening of the yield curve (where long-term and short-term debt yield the same) suggests that many traders are betting on tougher economic times.

High inflation, stoked by commodity-market disruptions due to the war, has increased pressure on the U.S. Federal Reserve and some other key central banks to tighten monetary policy.

While the Fed is tightening, expectations are growing that China will loosen monetary policy to support economic expansion.

China’s cabinet pledged stronger monetary-policy support while cautioning against flooding the market with liquidity, state broadcaster CCTV reported Monday.

Asian markets were higher Tuesdaywith Tokyo's Nikkei 225 (+1.68%), Sydney’s ASX 200 (+1.19%), Seoul's Kospi Index (+0.66%) and Hong Kong's Hang Seng Index (+1.06%) all up in the morning trading session.



1. China 737 Crash Couldn't Have Come at a Worse Time for Boeing

  • According to radar monitoring data, the China Eastern 737 took an abrupt and severe dive, close to its descent point when it started plunging at a far greater rate than normal.

  • Boeing’s shares plunged some 7% on the news, with many traders speculating that given the profile of the China Eastern crash, it could bring back fresh memories of issues that have plagued Boeing’s 737 MAX series of aircraft.

The aviation business is challenging even during the best of times.

Low margins, intense competition and the sheer amount of human and financial capital to maintain an aviation business is just part of the complexity, then there’s pandemic, plague, pestilence and now product risk as a Boeing 737 crash in China.

The world’s most profitable and popular short haul commercial airliner, the Boeing 737, has had many iterations since it first debuted in 1967 and while many have argued that the 737’s design is getting a little long in the tooth, it’s been a consistent earner for Boeing (-3.59%).

Rather than design a new short-haul aircraft, Boeing stuck with the same airframe from 1967, making many modifications for fuel efficiency and ensuring that pilot training time would be kept to a minimum.

From the original 737, there are now just over half a dozen variants from the third generation and fourth generation that are widely in use.

The 737 MAX series, from the fourth generation made headlines when two of the variants crashed in separate, but closely related incidents that have been the subject of controversy since and which have been attributed to issues with the systems on the aircraft as well, with changes not communicated to the pilots who fly them.

And while the Boeing 737 MAX has been cleared by the U.S. Federal Aviation Administration, after a lengthy grounding and reworking of the plane, this recent crash of a China Eastern Boeing 737-800 in southern China could put the kibosh on the company’s major revenue earner.

Although details of the China Eastern crash yesterday are just coming in, the profile of the accident is disconcerting to say the least.

The cruise phase of a flight is typically the safest, with the bulk of aviation accidents occurring during takeoff and landing and few, if any, fit the extreme profile of the China Eastern 737-800 crash as it pointed steeply to the ground and plunged from its cruising altitude of 29,000 feet.

According to radar monitoring data, the China Eastern 737 took an abrupt and severe dive, close to its descent point when it started plunging at a far greater rate than normal.

Instead of gradually dropping by a few thousand feet per minute, as per normal, it Boeing jet plummeted at a rate of more than 30,000 feet per minute, in mere seconds, according to data logged by FlightRadar24.

According to FlightRadar24 data, the China Eastern 737 fell 26,000 feet in around one and a half minutes – equivalent to a near-vertical nosedive.

Although it is too early to speculate, there are very few reasons why a commercial airliner would make take such a precipitous dive and it’s entirely possible that the Boeing 737 may have other critical design or manufacturing issues that could come to light.

While things like a pilot suffering an incapacitation like a heart attack and slumping on the control column or a malfunction remains a possibility, these sorts of issues would not see such a prolonged and sudden dive.

Boeing’s shares plunged some 7% on the news, with many traders speculating that given the profile of the China Eastern crash, it could bring back fresh memories of issues that have plagued Boeing’s 737 MAX series of aircraft.

To be sure, the jet in yesterday’s crash was a third generation Boeing 737-800 that has operated for years without issue, with the first of that variant launched in 1998.

But because the Boeing 737-800 is the world’s most widely used narrowbody aircraft, competing directly with the Airbus A320, any critical failures that can be pinned to its design or manufacture would be a serious blow to Boeing at a time when it’s just recovering from the pandemic.



2. Beijing Bolsters its Dry Powder to Spend for Later

  • Beijing has stockpiled a record amount of cash in the first two months of the year, despite pledges to speed up a fiscal boost.

  • Government deposits, which are listed under liabilities in the People’s Bank of China’s balance sheet rose by a combined US$184 billion from January to February, the biggest increase since 2000.

A slowing economy and continued crackdowns on various key economic sectors hasn’t led to Beijing opening up its pocket book just yet to start spending.

While key Chinese economic officials have pledged to do more to lift the economy, in reality, Beijing has stockpiled a record amount of cash in the first two months of the year, despite pledges to speed up a fiscal boost.

According to Bloomberg calculations based off official figures, government deposits, which are listed under liabilities in the People’s Bank of China’s balance sheet rose by a combined US$184 billion from January to February, the biggest increase since 2000.

These figures suggest that Beijing is spending far less than the income it’s getting from sources such as local bond sales and tax revenue and contradicts pledges to “front load” stimulus to bolster a faltering economy.

Investors have bid up Chinese equities last week, as Beijing pledged to do more to shore up its moribund economy and battered markets, with a sharp rebound in Chinese stocks.

But global investors have also used the opportunity to cash in their chips on Chinese equities, sucking a massive US$6 billion from them collectively, in the biggest outflow of foreign money since 2015.

Nevertheless, Beijing may be holding back to spend later, as having more dry powder lets it deploy where necessary as the Communist Party seeks to push up spending.

China’s top leaders have already pledged to “advance infrastructure investment” in a bid to reinvigorate the Chinese economy that has languished by a housing market slump of its own making, as Beijing cracked down on the highly levered real estate sector.

Complicating matters for Beijing, a spike in coronavirus infections, fresh pandemic lockdowns of entire cities and spiking commodity prices as the Russian invasion of Ukraine rages on are also acting as headwinds for the Chinese economy.

Beijing targets 5.5% of growth for this year and despite a strong start to 2022, may appear overly ambitious.

Chinese bank lending slumped further in February, pointing to still sluggish corporate demand for loans, while home mortgages declined for the first time in 15 years, all suggesting that private enterprises are not buying into the narrative from Beijing.

Which could be why Beijing needs to hold on to dry powder, as infrastructure spending, which will have a knock-on effect on construction and other sectors, may be needed later on, to serve as an engine of growth in a politically sensitive year.

Chinese President Xi Jinping looks set to install himself for a third term and potentially become leader for life, and economic stability is a key backdrop for such an unprecedented move since Chinese leader Deng Xiaoping shifted to a communal leadership system.

But it’s not clear exactly how much infrastructure spending can help.

China already has countless “ghost cities” and massive airports and railway stations that are barely utilized.

Building more bridges and roads that nobody drives on will hardly make a country rich, but if nothing else, provide a welcome distraction from the real economic woes facing China – a turn to centralization and a strangulation of the entrepreneurial spirit that marked the country’s breakneck growth over the past three decades since its reform.



3. Cryptocurrencies Get their Over-the-Counter Moment

  • Goldman Sachs Group (-1.85%) executed its first ever OTC cryptocurrency options trade, in a further step to expand digital asset offerings to Wall Street investors.

  • Ultimately, institutional investors will now have more ways to bet on Bitcoin’s price in either direction, and much of that will be away from the prying eyes of the market.

The world of financial derivatives is often opaque and inaccessible.

Because many derivatives are traded over-the-counter or OTC with other counterparties, it’s hard to put a finger on how significant or large the size of the derivatives market is, unless of course, something goes horribly wrong, as was the case of Archegos Capital Management.

In the case of Archegos, the family office run by Bill Hwang, a former “Tiger Cub,” a term used to describe ex-employees at Tiger Management, forced liquidations of over US$20 billion in holdings almost crashed the market and led to billions of dollars in losses for some of the biggest banks.

Much of the leverage used by Hwang was provided directly by banks, including Nomura Holdings and Credit Suisse Group through swaps and contracts-for-difference, meaning that Archegos probably never owned most of the underlying securities, if any at all.

These OTC derivatives traded by Archegos are transacted off exchange, allowing managers like Hwang to amass massive positions in publicly-traded companies without having to declare such exposure.

And now it appears that those same style of OTC products are bleeding the cryptoverse into that of traditional finance as Goldman Sachs Group (-1.85%) executed its first ever OTC cryptocurrency options trade, in a further step to expand digital asset offerings to Wall Street investors.

Similar to the CME Group’s (+0.46%) cash-settled Bitcoin futures, the Goldman Sachs options are non-deliverable, meaning that while the derivative is tied to Bitcoin’s price, it pays out in cash.

But unlike the CME Group’s product, who buys these options and how much they cost is completely opaque, as is the nature of OTC markets.

While many crypto traders use options to hedge risk or gin up returns, OTC transactions are typically larger trades negotiated privately and may usher in a new era where counterparties have far more exposure to the nascent asset class than publicly declarable.

Last year, Goldman Sachs opened up trading of non-deliverable forwards, akin to CME Group’s Bitcoin futures, and are a derivative tied to Bitcoin’s price that settles in cash.

Ultimately, institutional investors will now have more ways to bet on Bitcoin’s price in either direction, and much of that will be away from the prying eyes of the market.

On the flipside, Goldman’s move to make more crypto derivatives available and could nudge other banks sitting on the fence about crypto to use OTC as a conduit for trading cryptocurrencies.

Because derivatives can be cash-settled, banks don’t have to deal with issues of custody, which raises expensive and clunky investigations into the source of the underlying digital asset, as well as KYC and AML baggage that typically goes along with that.

And while familiar names like Goldman Sachs could help pave the way for greater institutional adoption, they could also usher in a period of immense speculation, similar to the opaque mortgage-backed securities that contributed to the 2008 Financial Crisis.

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