Hello there,

A terrific Tuesday to you as stocks waver over inflation fears on the last day of May, a month that has ended well (all things being considered) but provided no shortage of volatility for investors.

In brief (TL:DR)

• U.S. stocks marked a second consecutive day of gains last Friday and ahead of the Memorial Day long weekend with the Dow Jones Industrial Average (+1.76%), S&P 500 (+2.47%) and the Nasdaq Composite (+3.33%) all higher, but investors will be waiting to see what happens at the open,

• Asian stocks fluctuated Tuesday as investors question whether central banks can raise interest rates to rein in inflation without derailing growth.

• Benchmark U.S. 10-year Treasury yields rose about 10 basis points to 2.84% (yields fall when bond prices rise) but yields look set to rise when the U.S. reopens later today after the long weekend.

• The dollar rose slightly in Asian trading.

• Oil gained with July 2022 contracts for WTI Crude Oil (Nymex) (+2.54%) at US$117.99 after the European Union backed a push to ban some Russian oil.

• Gold fell with August 2022 contracts for Gold (Comex) (+0.19%) at US$1,853.80 on the back of a rising dollar.

• Bitcoin (+4.94%) rose to US$31,674, as investors and strategists said the digital currency is showing signs of bottoming out and evidence that the "smart money" is pouring back into the space.

In today's issue...

1. You Turn if you want to, The Fed’s Not for Turning

2. Oil Blasts Through US$120 a Barrel to Fuel Inflation Headaches

3. The Good News is Tether May be Backed by “Some” Dollars at Least

Market Overview

Global stocks are on track to end the month with modest gains amid skepticism about whether the market is near a trough and as volatility stays elevated.

Fears that central bank rate hikes will induce a recession, stubbornly high inflation and uncertainty around how China will boost its flailing economy are keeping investors watchful.

Higher energy and food costs are keeping upward pressure on prices globally and squeezing consumers.

Asian markets were mixed with Tokyo's Nikkei 225 (+0.02%), Seoul's Kospi Index (+0.25%) and Hong Kong's Hang Seng Index (+0.34%) up, while Sydney’s ASX 200 (+0.64%) was down in the morning trading session.

1. You Turn if you want to, The Fed's Not for Turning

• 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.

Yesterday, this newsletter suggested that investors were being lured into a sense of security that the U.S. Federal Reserve would not be as hawkish as initially thought, after pouring through the minutes of the last Federal Open Market Committee meeting.

Comments by Atlanta Fed President Raphael Bostic at a Rotary Club luncheon also hinted at a possible “pause” in rate hikes in September, fueling further speculation that the central bank may not tighten conditions as much as thought.

But these assumptions are precisely that – assumptions.

So it wasn’t altogether surprising that 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.

In a speech at the Goethe University in Frankfurt, Germany on Monday, U.S. Federal Reserve Governor Christopher Waller, one of the central bank’s most hawkish members, said he backed increasing rates by another 50-basis-points “for several meetings”

Waller added that he would not stop that pace, “until I see inflation coming down closer to our 2 per cent target.”

Whether Waller’s comments are just bluster or reflect the majority view at the Fed is less clear.

Minutes from the last rate-setting meeting at the Fed suggest a central bank that remains cognizant of the risks of tightening too hard and too fast, and its potential impact on the U.S. 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.

Nevertheless, the likelihood is that June and July will see two additional 50-basis-point rate hikes, so that the Fed gets closer to its neutral monetary policy, before things become more uncertain.

Whereas the pace of inflation appears on the surface to be slowing, prices remain elevated and policymakers will have their work cut out for them ahead of the U.S. midterm elections and with the cost of living a hot button political issue.

Bearing in mind that September’s rate hike is just ahead of the November midterm elections in the U.S., the Fed’s decision at that time will take on added political significance, even if policymakers are meant to be apolitical.

In reality, central bankers are still (somewhat) beholden to their political kingmakers, who got them into their roles to begin with.

2. Oil Blasts Through US$120 a Barrel to Fuel Inflation Headaches

• 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.

While most investors would associate the price of crude oil with what goes into our cars, trucks and planes, the price of black gold or Texas Tea actually affects everything from the price you pay for an air ticket to how much the toys under the tree cost at Christmas.

Oil is an important source of energy, but also an essential feedstock that goes into everything from plastics to chemicals used in every aspect of modern life.

So, 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.

The prospect of the European Union putting the kybosh on Russian crude exports, in retaliation for its unprovoked invasion of Ukraine, has propelled oil to its highest level in two months.

Brent Crude, the international benchmark, hit US$120.50 a barrel on Monday, ahead of the July contract’s expiry on Tuesday.

The rally in crude oil comes as supplies of refined products such as gasoline and diesel, remain tight at major delivery hubs and against a backdrop of rising demand, especially in the U.S., ahead of the summer driving season.

Almost all of the rise in oil prices can be attributed to the ongoing Russian invasion of Ukraine, which has seen Western allies shun crude cargoes coming from Russia and exacerbating already tight supplies.

By way of comparison, oil is just shy of its all-time high of US$147.50 a barrel, which it hit in 2008, before the Financial Crisis saw prices collapse soon after.

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

A combination of inflation, soaring energy prices, war and tightening central bank monetary policy could give way to a recession, something which markets don’t appear to be pricing in at the moment.

Oil prices affect consumption because already stretched consumers may dial back their consumption as more money buys less goods and services and discretionary expenditure such as travel either gets scaled down or given up altogether.

3. The Good News is Tether May be Backed by "Some" Dollars at Least

• 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.

Cryptocurrency investors have had a rough month.

From the collapse of the algorithmic stablecoin TerraUSD and its sister token LUNA, to the run on the stalwart “backed” stablecoin Tether or USDT, it’s no wonder that cryptocurrency markets have been bathed in a sea of red.

In a crisis of confidence, the collapse of TerraUSD, raised uncomfortable questions for the world’s most widely used dollar-based stablecoin USDT, which has always been cagey about revealing its reserves.

At one point scrutiny of Tether saw it slip its peg to trade as low as US$0.95, although it’s since more or less recovered from that level.

Nevertheless, Tether holders are not sticking around to find out if the stablecoin is truly backed or not, with over US$10 billion redeemed so far, which Tether has argued proves its ample liquidity.

Launched in 2014, Tether’s USDT is ubiquitous in the cryptocurrency markets and is the most widely available stablecoin-crypto trading pair, as well as the base currency for almost all derivative products.

Registered in the British Virgin Islands, Tether is no stranger to controversy, having entered into a settlement with the New York Attorney General’s office over irregularities regarding its past transactions and allegedly covering up the fact that USDT may not always have been backed by reserves at all times.

While TerraUSD’s collapse wiped off around US$100 billion in market cap from cryptocurrencies across the board, a result of its contagion effect, a collapse of USDT would be systemic and could be crypto’s Lehman Brothers moment.

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.

Tether has long struggled with establishing and maintaining banking relationships, at one point it was banking with JPMorgan Chase, before the bank unilaterally severed those ties.

For years, banks have generally been reticent to deal with cryptocurrency companies over concerns that the costs and risks far outweighed any benefits.

Banks that have opened their doors to cryptocurrency companies however have done well, riding up alongside the prices of the digital assets, including Silvergate Capital and Signature Bank.

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.

Capital Union has declined to confirm that it indeed does hold any of Tether’s cash assets, but according to an annual report, the boutique bank was founded in 2013, roughly around the time that Tether was created, and had assets of about US$1 billion at the end of 2020.