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Daily Analysis 31 August 2022 (10-Minute Read)

Hello there,

A terrific Thursday to you as markets continue to tank into a new month, given growing concerns over the U.S. Federal Reserve's resolve to tighten policy against inflation at all costs.

In brief (TL:DR)

  • U.S. stocks continued to fall on Wednesday with the Dow Jones Industrial Average (-0.88%), the S&P 500 (-0.78%) and the Nasdaq Composite (-0.56%) all down.

  • Asian stocks bled into Thursday on economic growth worries and central bank hawkishness pushing up the dollar.

  • Benchmark U.S. 10-year Treasury yields soared to 3.206% (yields rise when bond prices fall) as assets were hammered across the board.

  • The dollar firmed.

  • Oil sank with October 2022 contracts for WTI Crude Oil (Nymex) (-0.13%) at US$89.43 on continued concerns over demand resilience in the face of slowing economic conditions.

  • Gold slipped with December 2022 contracts for Gold (Comex) (-0.61%) at US$1,715.70.

  • Bitcoin (-1.56%) slumped to US$20,086 and looks set to dip below US$20,000, a key level of support, yet again as global sentiment sours for risk appetites.

In today's issue...

  1. Fed's Inflation Fight Making Inroads at Great Cost

  2. Gold Fails to Deliver as a Hedge Against Anything

  3. August was a Horror for Cryptocurrencies, September Could be Worse

Market Overview

Rattled by the U.S. Federal Reserve's apparent willingness to stomach higher unemployment and slower economic growth in its fight to tame inflation, investors suffered a brutal August and tumbled into September.

Restrictive monetary policy is raising fears of an economic downturn or recession and U.S. Treasury yields are reflecting increased stress, with yield curve inversion reflecting growing bets that economic malaise cannot be avoided.

Assets across the board have been hammered of late, from equities to bonds, commodities to cryptocurrencies, as macro plays an increasingly significant role in the markets.

Asian markets were bled into Thursday with Tokyo's Nikkei 225 (-1.49%), Seoul's Kospi Index (-1.92%), Sydney’s ASX 200 (-1.79%) and Hong Kong's Hang Seng Index (-0.84%) down in the morning trading session.

1. Fed's Inflation Fight Making Inroads at Great Cost

  • All asset classes are being hammered as the U.S. Federal Reserve maintains a fiercely hawkish stance in its fight against inflation.

  • 60/40 stock and bond portfolio allocations not spared as cross-asset correlation is the highest in months.

While some observers are suggesting the bubble in markets has yet to burst, that serves as cold comfort to investors who suffered the worst cross-asset selloff since 1981.

Equities, bonds and commodities fell against a backdrop of central bank policy tightening, heightened geopolitical risks and concerns over China’s rapidly slowing economy.

A Bloomberg index tracking high-yield corporate bonds performed the “least bad” losing “just” 1.9%, while U.S. Treasuries fell 2.2%, while commodities slipped 3.9% and the benchmark S&P 500 was hammered with a 4.2% drop.

July’s rebound where some US$4 trillion in market value was returned to equity and bond markets has been quickly unwound in August as the U.S. Federal Reserve doubled down on hawkish rhetoric, demonstrating its determination to reign in inflation, even at the expense of the economy.

Investors with a 60/40 stock and bond portfolio will be nursing losses as the strengthening correlation across asset classes has meant that stocks and bonds have faced headwinds in tandem as macro factors overshadow other considerations.

Even typically favored inflation trades such as commodities faced a stiff selloff, with oil posting its biggest monthly drop since last November and gold chalking up 5 straight months of declines, its longest losing streak in four years.

No asset has been spared as the Fed’s hard-driving inflation-fighting policy is brought to bear on markets that are already shaky, and a measure of cross-asset correlation tracked by Barclays sat near its highest level in 17 years.

After the S&P 500’s best July in 80 years, stocks have been hammered after U.S. Federal Reserve Chairman Jerome Powell’s hawkish message at the Jackson Hole forum, where he remained firm in his resolve to bring down prices even if it meant a “sustained period of below-trend growth” and an increase in unemployment.

Powell’s messaging differs markedly from previous public declarations where he left the door open to concepts such as a “soft landing” and the prospect of a less hawkish Fed should economic conditions worsen.

A slew of reports is due in the coming weeks that could seriously rattle markets, including a U.S. employment report on Friday and the inflation print for August that is due out before the Fed’s next policy meeting.

While bets on the size of the next Fed hike are evenly split on 50 and 75-basis-point increases, odds are that central bank policymakers will stick with the latter because inflation remains high.

Even if CPI dials back to 7.9% for August, thanks to falling oil prices, it is still well above the Fed’s target 2%.

Sticking with a 75-basis-point hike would be within expectations, as it is consistent with previous hikes, whereas dialing it back to 50-basis-points would be communicating to the market that the Fed is easing its pace of increases, which makes no sense given that inflation remains elevated.

Slowing down hikes now only to have to dial back up again later if inflation resurfaces will look amateurish and reactive.

2. Gold Fails to Deliver as a Hedge Against Anything

  • Price of gold sinks against a backdrop of rising interest rates, a stronger dollar and despite greater geopolitical uncertainty.

  • Gold fails to deliver as a hedge against uncertainty and inflation as a stronger dollar trumps its role in a portfolio.

In the past, gold represented more than just a store of value, it gave monarchs the power to raise armies, wage war and issue currency.

But the precious metal’s role in the modern and highly financialized economy has been somewhat more complicated.

Typically seen as a haven asset during times of uncertainty, gold has lost its luster as investors who hoarded bullion as a hedge against uncertainty in the wake of Russia’s invasion of Ukraine, have since seen the dollar value of their holdings dwindle.

And that’s because gold typically shines against a backdrop of a weak dollar, geopolitical instability and low interest rates, with only one factor present at the moment.

A weaker dollar mathematically raises the price of dollar-denominated commodities, of which gold is one, and lower interest rates help to paper over gold’s non-yielding properties.

Gold has experienced its fifth consecutive month of declines for the first time in four years and money managers are simply not buying the stuff.

ETFs which had held a mountain of gold in the wake of the Russian invasion of Ukraine have since whittled down their stakes to almost nothing.

Jewelry, which accounts for about half of gold demand has seen lackluster sales because as inflation causes consumers to tighten their belts and hold back on discretionary purchases.

Short interest in gold has also increased to the point that on Chicago-traded gold futures and options, net positioning was short in July before moderating in August to flat.

Gold has been around as an asset class for thousands of years, staring with the ancient Mesopotamians, but whether its dollar value is durable, especially in the short term and against a backdrop of tightening monetary policy is a different story altogether.

3. August was a Horror for Cryptocurrencies, September Could be Worse

  • Abysmal August for cryptocurrencies could pave way for historically terrible September, with Bitcoin historically falling around 9% in the month, according to data going back to 2017.

  • Possibility that the Merge for Ethereum, a key software upgrade, and due to be completed this month, could help to dampen some of the downside volatility for cryptocurrencies.

It’s a cruel, (cruel) cruel summer,

Leaving me here on my own

It’s a cruel, (cruel) cruel summer,

Now you’re gone

– Cruel Summer by Bananarama off the album Bananarama. Copyright 1983.

After a brief rebound in July, cryptocurrency markets, along with other assets, were hammered in August against the backdrop of tighter central bank monetary policy.

But even if the U.S. Federal Reserve spins a less hawkish tone at its upcoming policy meeting this month, history is not on the side of cryptocurrencies as September has typically seen the asset class tumble.

Every September since 2017, Bitcoin has averaged a 9% drop for the month over the past five years, according to Bespoke Investment Group, and this has tended to weigh down other cryptocurrencies as well, including Ether, which has typically seen double digit dumps in the same month.

Cryptocurrencies have had a terrible year so far, as central banks globally tighten monetary conditions to fight inflation and with growing geopolitical and economic uncertainty.

Cryptocurrencies and stocks have also resumed their reliable correlation, especially with U.S. tech stocks, represented by the Nasdaq 100.

September has also typically been a rough month for equities as well, as traders return to the office from summer holidays, increasing volumes and adding to volatility.

Ether has remained somewhat resilient because of optimism over the impending Merge, an upgrade of the Ethereum blockchain software to the far more energy-efficient Proof-of-Stake.

The recent outperformance of Ether relative to other cryptocurrencies has seen Bitcoin’s dominance of the total market cap of digital assets wane.



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