Hello there,

A fantastic Friday to you as markets flip around more times than a freshly caught fish from floundering to flying.

In brief (TL:DR)

• U.S. stocks closed higher on Thursday with the Dow Jones Industrial Average (+1.02%), the S&P 500 (+1.43%) and the Nasdaq Composite (+1.93%) all up.

• Asian stocks were steady Friday as investors weighed the resilience of the global economic recovery to risks from tightening U.S. Federal Reserve monetary policy and Russia’s ongoing military campaign in Ukraine.

• Benchmark U.S. 10-year Treasury fell one basis point to 2.36% (yields fall when bond prices rise).

• The dollar edged lower.

• Oil retreated with April 2022 contracts for WTI Crude Oil (Nymex) (-0.12%) at US$112.20 as European Union leaders refrained from fresh steps to cut imports of Russian crude.

• Gold rose with April 2022 contracts for Gold (Comex) (+0.11%) at US$1,969.90.

• Bitcoin (+3.06%) rose to US$44,155, in line with the sharp rebound in other risk assets.

In today's issue...

1. U.S. Mortgage Rates are Rising at the Worst Possible Time

2. Don’t Bet on a Deal for Chinese Listings in the U.S. Anytime Soon

3. Ethereum Classic Outperforms Rest of Crypto Market, Should You Buy?

Market Overview

Global shares are set for their first consecutive weekly gains in 2022, suggesting equity investors foresee economic growth weathering the conflict, high inflation and the Fed’s campaign against price pressures.

But key parts of the U.S. Treasury yield curve continue to flatten or are inverted. That’s stirring debate as to whether the bond market is flagging a steep economic slowdown or even a recession ahead.

Investors are continuing to grapple with the ramifications of Russia’s invasion and isolation, including elevated raw-material costs that have stoked expectations of higher inflation and more aggressive Fed interest-rate hikes.

Asian markets were mixed Friday with Tokyo's Nikkei 225 (-0.07%)and Hong Kong's Hang Seng Index (-0.52%) down, while Sydney’s ASX 200 (+0.32%) and Seoul's Kospi Index (+0.08%) were up.

1. U.S. Mortgage Rates are Rising at the Worst Possible Time

• U.S. mortgage rates are continuing their rapid rise and reaching levels not seen since well before the pandemic.

• Rising mortgage rates could eventually affect consumption though and while defaults are still low, if wages don’t increase to keep up with the costs of living, could set off a recession.

The thing about raising interest rates to combat inflation is that to begin with, monetary policy is a blunt tool to combat inflation – there’s no clear evidence that it works, but the other side effect is that it can put pressure on the economy in other ways as well.

And that pressure is starting to show up on the mortgage market, with U.S. mortgage rates continuing their rapid rise and reaching levels not seen since well before the pandemic.

The average 30-year loan servicing cost was 4.42%, up from 4.16% since last week and the highest since January 2019, according to a statement by Freddie Mac, a government-sponsored mortgage company.

Borrowing costs tracked another increase in benchmark U.S. 10-year Treasury yields which influence everything from mortgages to auto loans and in the wake of a U.S. Federal Reserve rate hike last week that lifted benchmark interest rates by 0.25%.

With the pace of inflation at its highest in 40 years, policymakers have communicated that they are willing to take more aggressive measures to reign in price pressures.

But it’s not clear if their policy moves will do much to help given that most of the current increases are due to roiled supply chains and Russia’s invasion of Ukraine which has made matters worse.

Rising mortgage rates could eventually affect consumption though and while defaults are still low, if wages don’t increase to keep up with the costs of living, could set off a recession.

Higher interest rates have also seen companies become less aggressive in their hiring and expansion plans and fundraising in the U.S. capital markets this year has been lackluster.

Demand for housing remains strong nonetheless, and that should help to pick up some of the slack should weaker buyers be unable to service higher mortgage rates, but investors will want to pay attention to this end of the market for weakness, especially as the Fed starts to runoff its balance sheet which includes mortgage-backed securities.

2. Don't Bet on a Deal for Chinese Listings in the U.S. Anytime Soon

• This year alone, global investors have taken some US$6 billion out of Hong Kong and Chinese exchanges and ADRs of Chinese firms have been languishing.

• Unlike quarterly profits and outlook, these are existential issues for investors and predictably, Chinese shares have been hammered in the wake of continued regulatory uncertainty.

Washington and Beijing are fast heading towards an impasse on the fate of listings of Chinese firms on American exchanges as yesterday, the U.S. Public Company Accounting Oversight Board said that it would be “premature” to speculate on the matter.

For over two decades, the stalemate between Washington and Beijing has meant that investors purchasing American Depository Receipts, or shares of Chinese companies listed in the U.S. has been akin to passing the parcel on their legal status.

American Depository Receipts or ADRs typically worked by providing a vehicle for Chinese companies, which then created offshore variable interest entities, usually in domiciles like the Cayman Islands, that would then list their shares on New York exchanges via these ADRs.

The convoluted legal structuring has always meant that it isn’t altogether clear what investors of ADRs of Chinese firms are buying, nor what their entitlement to the profits and proceeds of the main companies in China were.

As a matter of practice, the legal structuring hasn’t affected demand or liquidity for these ADRs, or their performance.

But now with Beijing tightening its grip on variable interest entities or VIEs, long a legal “gray zone” and Washington requiring greater transparency from these companies in terms of audit requirements, investors are understandably looking more closely at them.

This year alone, global investors have taken some US$6 billion out of Hong Kong and Chinese exchanges and ADRs of Chinese firms have been languishing.

The Trump administration toughened its stance on Chinese firms listed on American exchanges, requiring access to audit work papers, a sticking point for Beijing which has refused to grant such access, citing national security concerns.

Part of the problem could be that a deeper audit may reveal complex ownership structures that could ultimately tie shares in these lucrative firms back to high-level officials in the Chinese Communist Party, which would be politically embarrassing for Beijing which is allegedly pursuing “common prosperity.”

While the Chinese Securities Regulatory Commission is weighing a proposal that would allow U.S. regulator to inspect audit papers for some companies as soon as this year, the breadth and depth of such access remains to be seen and investors trying to figure out which companies are safe from delisting and which aren’t are walking into a veritable minefield.

Unlike quarterly profits and outlook, these are existential issues for investors and predictably, Chinese shares have been hammered in the wake of continued regulatory uncertainty.

So far, the U.S. Securities and Exchange Commission has identified six potential Chinese delistings, including Weibo (+1.35%), the popular Chinese microblogging website, while Beijing has refused access to ecommerce giant Alibaba Group Holdings (-1.49%) and search engine Baidu (-2.00%).

3. Ethereum Classic Outperforms Rest of Crypto Market, Should You Buy?

• One view is that as Ethereum moves to proof-of-stake, miners will need to shift their mining capabilities elsewhere, such as Ethereum Classic.

• And unlike Ethereum, Classic doesn’t enjoy the wide variety of applications and development that would form a ready source of demand for the token.

Nothing quite like the taste of Classic, Ethereum Classic.

At least that’s what the market appears to be communicating with the price of the hard fork of Ethereum surging more than 80% over the past week as speculators bet that cryptocurrency miners stuck on proof-of-work will switch over.

A short history lesson is needed to understand what Ethereum Classic is.

Early in Ethereum’s development, a nefarious actor which had gained access to the private keys to digital wallets for one of the Ethereum blockchain’s first applications, a Decentralized Autonomous Organization (“DAO”), drained wallets of the DAO.

While labeled a “hack,” once the thief had access to the private keys, there was nothing that anyone could do to stop them from making off with the cryptocurrency, estimated to be worth around US$165 million at the time.

The DAO was intended as a means by which cryptocurrency investors could deposit their Ether into smart contracts that would then invest in other projects using a voting system – a sort of decentralized venture capital fund.

In the wake of the hack, Ethereum’s core developers put it to a vote as to whether or not the proceeds of the hack ought to be recognized, or whether the ill-gotten gains that had been diverted to traceable wallets should be disregarded and that Ethereum should hard fork its software to make that happen.

Ultimately the community decided to disregard the stolen proceeds, Ethereum became the world’s second most valuable blockchain and those who persisted in their belief that if the point of the blockchain is that it should be an immutable version of the truth, regardless of how harsh, went on with the old software version that became Ethereum Classic.

Classic has languished for some time now, but as Ethereum heads towards a shift to proof-of-stake, where energy-hungry mining equipment isn’t needed to secure the blockchain, some traders are speculating that legacy miners will start shifting across to Classic.

Again, the issue at hand is ideological – there remains a hardened group that believes the only legitimate way to secure the blockchain is through proof-of-work, trading energy and computing power for the rewards of securing the blockchain.

Whereas a proof-of-stake model will allow massive holders a blockchain’s cryptocurrency to stake their holdings to secure the blockchain and arguably give them outsized influence.

One view is that as Ethereum moves to proof-of-stake, miners will need to shift their mining capabilities elsewhere, such as Ethereum Classic.

While more miners on Ethereum Classic would necessarily increase the network’s security, it’s also import to remember that miners pay for their energy and equipment in dollars, not crypto.

So there would be a constant selling pressure for Classic as miners keep dumping their tokens, paying for the ever-increasing cost of both equipment and energy.

And unlike Ethereum, Classic doesn’t enjoy the wide variety of applications and development that would form a ready source of demand for the token.

Just because a blockchain is more secure doesn’t automatically make it more valuable, usage and network effect are far more prized.