Hello there,

A whimsical Wednesday to you as markets wind their way marginally higher and Asia returns from the long weekend to find out what the U.S. Federal Reserve has in store for investors.

In brief (TL:DR)

• U.S. stocks were higher on Tuesday with the Dow Jones Industrial Average (+0.20%), S&P 500 (+0.48%) and the Nasdaq Composite (+0.22%) all up on expectations that the market can handle the impending 50-basis-point rate hike by the U.S. Federal Reserve.

• Asian stocks wavered amid a slide in Chinese technology firms in Hong Kong.

• Benchmark U.S. 10-year Treasury yields fell about one basis point to 2.97% (yields rise when bond prices fall) after hitting a high of 3% for the first time since 2018.

• The dollar held near two-year highs.

• Oil edged up with June 2022 contracts for WTI Crude Oil (Nymex) (+0.93%) at US$103.36.

• Gold slipped with June 2022 contracts for Gold (Comex) (-0.45%) at US$1,862.10 as yields soared making the non-yielding precious metal less attractive.

• Bitcoin (-1.58%) slipped to US$37,885 (at the time of writing) for the same reasons that have made gold less attractive - rising yields from haven assets like U.S. Treasuries.

In today's issue...

1. U.S. 10-Year Treasury Yields Hit 3% & Why You Should Care

2. Markets Are so Bearish They’re Looking Bullish

3. Coinbase Borrowing Against its Bitcoin is a Big Deal

Market Overview

The U.S. Federal Reserve is largely expected to raise rates by 50-basis-points Wednesday and detail plans for the reduction of its balance sheet, which investors should keep a close eye on.

Key for markets will be whether U.S. Federal Reserve Chairman Jerome Powell’s commentary contains any hawkish surprises that could stoke concerns about the threat of U.S. slowdown as borrowing costs climb.

The latest U.S. data showed record levels of job openings and workers quitting in March, pointing to the prospect of higher wages feeding into price pressures.

Asian markets opened lower Wednesday with Seoul's Kospi Index (-0.04%), Hong Kong's Hang Seng Index (-0.71%) and Sydney’s ASX 200 (-0.09%) all lower, dragged down by Chinese tech firms listed in Hong Kong, while Japan is still closed for the holiday.

1. U.S. 10-Year Treasury Yields Hit 3% & Why You Should Care?

• The combination of high inflation and a weakening global economic outlook, with the U.S. economy shrinking 1.4% year-on-year in the first quarter will provide sufficient food for thought as the U.S. Federal Reserve contemplates the aggressiveness of rate rises this week.

• The Fed is attempting the impossible, to peg policy at just the right temperature, not so tight as to tip into recession, but not so loose as to douse the fires of inflation with fuel.

For most of the decade and a bit since the 2008 Financial Crisis, a slurry of loose monetary policy and fiscal measures has helped depress yields and provided an over-worked justification for every and all manner of asset.

From growth stocks to cryptocurrencies, because the “safe” assets yielded negative real returns when catering for inflation, money flowed into whatever, wherever in search of yield.

But those arguments are now being tested as benchmark U.S. 10-year Treasury yields have touched 3% on Monday, the first time since 2018, which was the last time the U.S. Federal Reserve attempted to raise interest rates.

Yields on U.S. Treasuries have profound effects not just on the U.S. economy, but globally, with no shortage of banks from across the world using them as a benchmark to determine everything from mortgage rates to how much student loan debt costs.

But the combination of high inflation and a weakening global economic outlook, with the U.S. economy shrinking 1.4% year-on-year in the first quarter will provide sufficient food for thought as the U.S. Federal Reserve contemplates the aggressiveness of rate rises this week.

The Fed is having to contend with a macroeconomic environment steeped in contradictions, with rising labor costs against a shrinking economy, supply-chain problems, and high inflation, while China’s growth is slowing.

And while it’s clear that the U.S. economy isn’t in need of stimulus, what’s less clear is the pace at which existing accommodation needs to be removed and the reasons for keeping to that speed.

Markets have already priced in a 50-basis-point rate hike this week and futures markets are pricing in similar half-point rises at the next two meetings, taking short-term interest rates to 2.5% by the end of this year, which many economists project is the median course.

The Fed is attempting the impossible, to peg policy at just the right temperature, not so tight as to tip into recession, but not so loose as to douse the fires of inflation with fuel.

Across the globe, industrial activity is already slowing – China’s sprawling factory complex contracted last month at the fastest pace since February 2020, during the thick of the pandemic as the country’s economy reels from coronavirus lockdowns.

Purchasing manager indices released earlier this week also points to slowing growth in both the eurozone and U.S. factory sectors.

Assuming a slowdown in China, the world’s second largest economy, will not affect the rest of the world, would be naïve.

The rapid spike in bond yields is also acting as a headwind for stocks and gold, with the combination of higher rates and gloomy economic outlook hitting equities.

So where do we go from here?

Major U.S. equity indices still closed higher, with investors taking the opportunity to buy the dip and even tech shares saw a rebound.

What happens next will now depend on expectations and less on policy.

Because most traders have already priced in what the Fed is likely to do and since the central bank has so far stuck with a well-communicated policy to manage expectations, a lot will depend on whether supply chains can be come unstuck and the Russian invasion of Ukraine.

If inflation pressures ebb, but the threat of an economic slowdown is greater, central banks may ease off on the aggressiveness and urgency when it comes to tightening, and that could provide a boost for risk assets.

2. Markets Are so Bearish They're Looking Bullish

• Widely used as a fear vs. greed gauge, the VIX has now swung so far in the negative that there are some on Wall Street who think that a sharp rally in stocks may be in the offing.

• Meanwhile, the VIX has been at over 30 for the past week – with traders typically noting that readings over 30 are a sign of significant fear in the market.

If the day is darkest before the dawn, then markets are starting to look at that point, at least according to the Cboe Volatility Index futures spread, otherwise know as the VIX.

Widely used as a fear vs. greed gauge, the VIX has now swung so far in the negative that there are some on Wall Street who think that a sharp rally in stocks may be in the offing.

Ahead of the U.S. Federal Reserve’s policy meeting today, the U.S. put (bearish option to sell at a certain price) to call (bullish option to buy at a certain price) ratio’s absolute level is near the highest since January, after investors beefed up hedges into the falling market amid growing concerns of a recession and aggressive policy tightening.

Outside of an unexpected sharp interest rate hike by the Fed, the unwinding of these hedges should provide some support to U.S. equities as investors square off positions after the Fed’s interest rate decision today.

Meanwhile, the VIX has been at over 30 for the past week – with traders typically noting that readings over 30 are a sign of significant fear in the market.

Significantly, the spread between 2-month and 8-month VIX futures contracts are trading near peak levels seen earlier this year, reflecting the deep uncertainty regarding the near term.

Such indicators of short-term stress have historically been turning points for risk assets, with volatility peaking in the days leading up the Fed’s prior three meetings this year.

Plucky investors could be positioning themselves for a rally, because if the Fed acts as more or less expected, that uncertainty will be resolved and markets could rally in response.

Given the slew of uncertainty in the markets at the moment, taking at least one variable out of the equation – monetary policy – would be sufficient to help investors heave a sigh of relief and perhaps whet some appetite for risk.

3. Coinbase Borrowing Against its Bitcoin is a Big Deal

• Coinbase is the first corporate to actually use Bitcoin on its books to borrow money.

• While Bitcoin-backed loans are not new for DeFi, they could revolutionize traditional finance if they gain enough traction on Wall Street.

“If you told me you own all of the bitcoin in the world and you offered it to me for $25, I wouldn’t take it because what would I do with it? I’d have to sell it back to you one way or another. It isn’t going to do anything.”

– Warren Buffett, Berkshire Hathaway

While Buffett suggests that Bitcoin doesn’t “do anything,” the experience of Coinbase Global (+1.83%) has proved that it can be used to “do something” and that something is borrow money.

Although decentralized finance or DeFi practitioners have long used their stacks of Bitcoin do “do something,” from borrowing to contributing to liquidity pools to generate yields, Coinbase is the first corporate to actually use Bitcoin on its books to borrow money.

Last month, Goldman Sachs (+1.37%) unveiled its first ever lending facility backed by Bitcoin and that could potentially entice other companies to load the cryptocurrency onto their balance sheet.

While Bitcoin-backed loans are not new for DeFi, they could revolutionize traditional finance if they gain enough traction on Wall Street.

Silvergate Bank and Signature Bank (+1.80%), both of which are crypto-friendly, have been known to have already structured similar Bitcoin-backed loans, but a marquee name like Goldman Sachs has proved elusive until now.

Because of Bitcoin’s volatility, such loans typically only provide a loan-to-value of as low as just 40%, to as high as 60%.

Bitcoin has been trading within a relatively tight channel of late, given the uncertainty surrounding the macro environment and the prospect of policy tightening, which is alleged to be the main driver behind demand for the cryptocurrency.

Some observers suggest that Goldman Sachs move to provide a Bitcoin-backed facility is not likely a one-off transaction and is in response to heightened demand for this type of transaction.

If so, companies that already have Bitcoin on their balance sheets like Block (-3.33%) (formerly known as Square) and MicroStrategy (-6.15%), could utilize these assets to take on more borrowings and other companies that don’t yet have the cryptocurrency on their books, may be inclined to put it on.

Either way, that Bitcoin holders could monetize their Bitcoin without selling it, is a significant qualitative shift on the use case for the cryptocurrency.