LD Macroeconomic Weekly Report [2023/06/26]: Recession Fears Stir Markets: Cryptos Thrive as Stocks Stumble
Abstract
Last week, central bank officials from the U.S. and around the globe reaffirmed the need for further monetary tightening to control inflation, during which the U.S. stock market experienced its worst week since March. However, cryptocurrencies enjoyed their strongest rebound since March, bolstered by the entry of traditional financial giants and weekend political instability in Russia.
In his congressional testimony, Jerome Powell warned that markets should anticipate more interest rate hikes in the coming months and stated that there is a “long way to go” to bring inflation back to the Fed’s target range, causing market unease. This rhetoric contrasts with data from last week, showing a decline in several key inflation indices since July last year. Additionally, Purchasing Managers’ Index (PMI) data indicated a significant decrease in price pressure in manufacturing surveys and a drop to a nearly three-year low in the services report.
Traditional Capital Markets Review:
Global stock markets suffered their worst week since the Silicon Valley Bank collapse in March, signaling a potential end to the three-month bull market. Investors were startled by the new wave of aggressive tightening by global central banks, such as the Bank of England unexpectedly raising its interest rate by 0.5%, marking the 13th consecutive rate hike, with the Swiss, Norwegian, and Turkish central banks also increasing their rates. There are signs that the central banks’ actions have finally cooled the economy, with business activity in Europe sharply slowing down in June, and although US business activity has also slowed, it’s much less so than elsewhere in the world.
This week’s partial pullback was also technically driven, as the S&P 500 encountered resistance levels. Last week, the index climbed above 4400 points for the first time since April of last year. Since January, the S&P 500 has fluctuated between 3800 and 4200 points most of the time, with a very quick rise from 4200 to 4400 points.
The three major market averages all broke their consecutive weeks of gains: the S&P 500 fell by 1.4%, ending a five-week rising streak; the NASDAQ also declined 1.4%, putting a stop to an eight-week rise; the Dow Jones fell 1.7%, ceasing its three-week gain.
Looking at the industry, distributors and the healthcare sector barely closed higher, while technology and raw materials experienced the greatest declines. Defensive stocks outperformed cyclical stocks.
Oil, gold, and copper all declined, primarily due to recession concerns and higher interest rate expectations.
In the bond market, the yields on 3-month, 1-year, and 2-year government bonds rose slightly, while those on 10-year and 30-year bonds were basically flat. The 1–10 year yield spread rose to 160 basis points in the middle of the week, the highest level of inversion since 1981.
Cryptocurrency Market Review:
In stark contrast, the digital currency market experienced a completely different scenario, benefiting from numerous traditional institutions re-entering the crypto market. Cryptocurrencies experienced their largest weekly rebound since the banking crisis in March, with BTC bouncing back above $31,000 and Ethereum rebounding above $1,920, registering weekly increases of 15% and 9% respectively.
This surge in cryptocurrency coincided with several traditional finance (TradFi) giants, including BlackRock, Invesco, and WisdomTree, submitting applications for spot Bitcoin ETFs. At the same time, the EDX cryptocurrency exchange, backed by key TradFi participants, launched on Tuesday. The exchange, supported by Fidelity Digital Assets, Charles Schwab, and Citadel Securities, will offer four tokens in the US, including BTC, ETH, BCH, and LTC. Other developments include Deutsche Bank, a banking giant, announcing on Tuesday that it has applied for a digital asset custody license in Germany.
TradFi participants seem to be undeterred by the SEC’s regulatory crackdown on cryptocurrency exchanges. However, these announcements are more of a mood booster for the industry and may not necessarily result in substantial capital inflows.
There are several Crypto ETFs, among which the largest is BITO, which uses CME futures to track BTC prices. BITO has performed excellently and charges a relatively low fee (0.95%/year, much lower than GBTC’s 2%), but its net assets amount to only about $900 million. The scale of other products is only a few tens to hundreds of millions of dollars, which can be ignored. This shows that US stock funds do have compliant tools to participate in the rise and fall of digital currencies. From a trading perspective, even if a spot ETF comes out, it may not necessarily attract a large amount of capital inflow, especially considering the higher custody costs of spot ETFs. The expected fee rate is at least 1.5% or more, and the holding experience may not be as good as that of futures ETFs.
Additionally, there have been previous instances of large institutions supporting crypto exchanges, such as the BAKKT crypto exchange established by the Intercontinental Exchange (ICE), the largest exchange by revenue globally. Its trading volume was only $190 million in Q1 of this year. In comparison, CoinGecko’s top 10 cryptocurrency exchanges had a spot trading volume of $2.8 trillion in Q1, leaving BAKKT accounting for just 0.007% of that total. Also, the outstanding BTC futures contracts volume on the CME futures market is roughly half of Binance’s, raising questions about whether platforms that comply with regulation at the expense of retail trading can indeed bring about a ‘revolution’.
Centralized exchanges have seen stablecoin inflows for two consecutive weeks, with balances rising from $17.5 billion (the lowest level since April 2021) to $18.7 billion, marking the longest growth since the end of last year. However, balances at exchanges were over $40 billion at that time, indicating that overall levels are still quite low.
Our Commentary:
From a macro perspective, the rebound in cryptocurrencies began on June 14, when the Fed first paused interest rate hikes. Although a higher end-point forecast for interest rates was released, the market did not overly focus on this prediction. The broader discussion was centered on the end of the entire rate-hiking cycle in the second half of 2023, which may be perceived as being a step closer to starting rate cuts. Of course, we believe it’s unlikely to see rate cuts this year unless any shock pushes the economy into a more severe recession.
The stock market had a new speculative focus — AI, and crypto faced the most severe allegations from US regulators in its history, leading to a collapse in correlation between the stock market and crypto. We suspect that the withdrawal of professional players might have led to a decrease in crypto’s sensitivity to macroeconomic conditions. For instance, last week global equity markets shuddered at aggressive central bank moves, but crypto ignored this entirely. The higher interest rate expectations released on the 14th should have been a significant bearish factor for non-interest-bearing assets, which was priced in by gold (price dropped from $195x to $192x).
Given the reaction to news, recent crypto market pricing is highly emotional with little logic to rely upon, and we advise against short-term participation unless one intends to hold for the long term. This lack of logic includes new rounds of institutional participation and Coinbase’s unrelated legal victory at the US Supreme Court.
In the medium term, fixed income products remain attractive. Although money market funds have seen outflows in the past two weeks, these gaps have been offset by inflows into bond funds, suggesting high bets on further rate increases, like record bond futures shorts. Given that the Fed and the ECB are expected to raise rates by 25 basis points in July, and the Bank of England will follow suit in August, such bets make sense. Therefore, the fundamentals for substantial upside in the stock market or crypto are not solid in the short term.
However, in the long run, leading indicators of inflation continue to fall, including payment price indices in manufacturing and services PMI and used car prices. The gradual decline in inflation and the change in Fed policy suggest that the foundation for a new bull market is forming. In terms of stocks, by 2024, lower interest rates and better earnings trends are generally expected scenarios by professional institutions. By then, compounded with the Bitcoin halving, it will be a stage of greater certainty for crypto investments.
Economic Data
U.S. manufacturing output drops as suppliers cut prices sharply
Most of the economic data last week seemed to deepen concerns that tightening monetary policy is pushing the U.S. towards a recession. On Friday, U.S. manufacturing PMI had fallen to its lowest level since December of last year, significantly below market expectations. The report also showed that suppliers are cutting prices at the fastest rate since May 2020 during the Covid period, possibly in response to weak demand.
Although Federal Reserve Chairman Jerome Powell insisted to Congress that the labor market remains tight, the number of weekly jobless claims reached 264,000, close to the revised figure from last week, which was the highest level since October 2021. However, the real estate sector showed some surprising strength with the number of new home starts at the highest level in over a year, much higher than predicted. Existing home sales were also slightly better than expected.
BoE Accelerates Rate Hikes as Inflation Fails to Slow
The Bank of England unexpectedly raised its key interest rate by half a percentage point to 5.0%, the highest level since 2008. Following unexpectedly strong inflation data, the Monetary Policy Committee (MPC) voted 7–2 to speed up the pace of policy tightening. The MPC stated, “There is significant upside news in the recent data, indicating stronger persistence in the inflation process.”
Inflation remained high in May, with CPI growth still at 8.7%. Excluding volatile food and energy prices, core inflation (shown in the yellow bar in the chart below) accelerated from 6.8% in April to a 31-year high of 7.1%.
Swiss, Norwegian Central Banks Raise Borrowing Costs to Tackle Inflation
The Norwegian central bank raised its key interest rate by 0.5 percentage points to 3.75% — the highest level since 2008 — and indicated that it is “most likely” to raise rates again in August to curb “significantly above target” inflation. The Swiss National Bank increased its benchmark rate by a quarter of a percentage point to 1.75%, the fifth consecutive increase, and did not rule out the possibility of further hikes.
Eurozone PMI nearly unchanged; German producer prices slow, Ifo predicts deepening economic contraction
S&P PMI data shows that despite a sixth consecutive month of business output growth in the eurozone in June, it almost stagnated, suggesting the economy is showing weaknesses once again after an initial recovery at the beginning of the year. The Eurozone Composite Purchasing Managers Output Index fell from 52.8 in May to a five-month low of 50.3.
In May, Germany’s producer prices rose at the slowest pace since July 2021, potentially a sign of slowing inflation. Annual producer prices rose 1.0%, below 4.1% in April. At the same time, the Ifo Institute predicts that Germany’s economy will contract by 0.4% in 2023, worse than the 0.1% forecast in March.
Investor Positioning and Fund Flows
This week, CFTC futures data showed a significant increase in net long positions in U.S. stocks. The overall net short in bonds increased and hit a new historical high.
From the investor classification perspective, both systematic investors (institutions) and discretionary investors increased their positions significantly, especially systematic investors whose positions have reached the 84%, which is considered a high level. Discretionary investor positions are at 58%, indicating a neutral to slightly bullish stance.
EPFR Global fund flow data showed a mix of sentiments, with a net outflow of $13.9 billion from money market funds, a $5.4 billion inflow into bond funds, a $1 billion outflow from gold funds, and a $5 billion loss from equity funds. In particular, the amount of tech stocks being sold hit a ten-week high with a total outflow of $2 billion, while financial stocks saw the largest inflow in ten weeks, reaching $1 billion.
The AAII investor confidence survey showed a slight decline in bullish sentiment from the November 2021 peak, a rebound in bearish sentiment from the lowest level in two years of 22.7% to 27.7%, and a drop in the proportion of neutral investors to the lowest level of the year:
The CNN Money Fear & Greed Index fell slightly to 74 this week, slightly below the extreme greed threshold of 75:
Bank of America’s Bull & Bear Indicator fell from 3.6 to 3.4, the lowest level since the beginning of May:
Goldman Sachs’ institutional sentiment indicator rose slightly and has remained at overbought levels for two consecutive weeks:
The Week Ahead
With concerns about economic recession once again becoming the center of conversation, investors may approach the last week of the quarter with a slightly more cautious attitude. In addition to continuing to digest hawkish central banks, the announcement of the Federal Reserve’s annual stress test results will be a major focus for the banking sector, and more uncertainty in the results could put pressure on bank stocks for a longer period of time.
Stress Test
The answer to the annual Dodd-Frank Act stress test, a regulatory requirement that large U.S. banks must undergo, will be announced on June 28. The test examines whether these banks have enough capital reserves to withstand an economic downturn by simulating a variety of economic scenarios set by the Federal Reserve. This process has a significant impact on the banks’ capital reserves, determining how much capital they can return to shareholders and affecting their short-term profitability.
In the past few years, the results of this test have always brought some surprises, such as some banks might need to increase their Common Equity Tier 1 (CET1) ratio, reduce dividend payments or share buybacks.
However, we think the chances of a surprise this year are somewhat lower, because with the ‘rehearsal’ of the March crisis, there is reason to believe that large banks have learned how to better handle this process.
Greater pressure on the banking sector might appear in the future. For instance, the Federal Reserve might consider introducing new rules related to the “Basel III Final Rules” (also known as “Basel IV”), the failure of Silicon Valley Bank and First Republic Bank, and the confidence crisis sparked by liquidity and term mismatch of regional banks. For example, capital buffer requirements are almost certain to rise. These subsequent changes could significantly impact the operational performance of many banks.
Geopolitics
A coup attempt in Russia ended in failure. The leader of the Wagner mercenary organization, Yevgeny Prigozhin, announced a halt to the advance on Moscow. The Kremlin said that Putin assured the Wagner leader a trip to Belarus and dropped criminal charges against him and the rebel fighters. However, authorities stated that Monday would still be a non-working day following the declaration of a state of emergency in Moscow. In a statement, the Central Bank of Russia declared that trading on the Moscow Exchange would proceed as usual on Monday.
The dramatic coup attempt in Russia over the weekend provided support for the cryptocurrency market, with BTC and ETH refreshing highs not seen since May of last year during this period. Assets symbolic of the free flow of money typically perform well in periods of international geopolitical tension. However, as the parties involved in the event quickly reached a compromise, such support might fade this week.
Data
In terms of data, the focus in the U.S. will be on the May PCE data to be released on Friday. The market currently anticipates a decrease in May PCE from 4.4% to 3.8%, while core PCE will remain high at 4.7%. The core PCE in the U.S. for April exceeded expectations and accelerated. If the data does not exceed expectations, the market might become more convinced that the Fed will only raise interest rates one more time. Consumer confidence data on Friday will also be a focus for the market, with expectations that this data will remain steady.
In Europe, the focus will be on inflation data to be released on Friday. The European Central Bank recently warned that the data need to improve significantly to avoid another rate hike next month.
China will release manufacturing and non-manufacturing PMI for June, with the market expecting a slight rebound in manufacturing and a possible slowdown in non-manufacturing. Currently, market participants are waiting for China to roll out new fiscal stimulus measures.
Central Banks
Regarding central banks, speeches by ECB President Christine Lagarde on Tuesday and Federal Reserve Chairman Jerome Powell on Wednesday will be widely watched. The governors of the Bank of Japan and the Bank of England will also speak alongside Powell on Wednesday. Overall, the governors are likely to continue conveying a hawkish tone.
LD Capital is a leading crypto fund who is active in primary and secondary markets, whose sub-funds include dedicated eco fund, FoF, hedge fund and Meta Fund.
LD Capital has a professional global team with deep industrial resources, and focus on develivering superior post-investment services to enhance project value growth, and specializes in long-term value and ecosystem investment.
LD Capital has successively discovered and invested more than 300 companies in Infra/Protocol/Dapp/Privacy/Metaverse/Layer2/DeFi/DAO/GameFi fields since 2016.
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