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Week Ahead – Georgia reopening fallout, three big rate decisions, and big Tech earnings

Week Ahead – Georgia reopening fallout, three big rate decisions, and big Tech earnings



Global equities and the US dollar appear to be approaching a possible turning point with the stimulus trade.  Global equities have been widely supported by unprecedented stimulus from central banks and governments, but that seems to be losing some of its firepower, while the steady demand for US Treasuries has buoyed the dollar.  The next major move with risk appetite will likely stem from expectations on when key economies reopen.

In the US, Georgia will give key insights to how comfortable businesses and consumers are with reopening their economy.  The risks of seeing a spike in cases over the next few weeks seem fairly high and that could eventually set them back even further if they have to return to lockdown mode.  Georgia is one of the most important stories right now as it could potentially provide a path on what to expect when other states reach their thresholds to begin reopening.

The focus next week will remain on COVID-19, rate decisions by BOJ, Fed and ECB, big tech earnings, a plethora of data shows how bad economic conditions got in the first quarter and how China’s recovery is unfolding.

The Fed’s handling of the coronavirus pandemic has many investors looking beyond the April 29th policy meeting. The Fed’s action has been quick and so far effective in alleviating many strains in the financial system. The Fed should take a pass at this meeting after already delivering a smorgasbord of stimulus measures, which include cutting rates to near zero, massive QE, supporting money market mutual funds, repo operations, support for small-and mid-sized business, relief to state and local governments, all while working with Congress.

A great amount of attention will go to the US advance reading of first quarter GDP. The economy likely contracted anywhere between -7.0% to -1.0% since the coronavirus only impacted the month of March. The consensus estimate is for a 3.7% drop. Expectations are already bad for second quarter GDP to fall nearly 40%, but if the baseline is much worse than expected, we could see risk aversion prevail.

Earnings season heats up this week with huge results from technology, industrial, finance and energy stocks.  Thursday will be the main event with both Apple and Amazon reporting after the close.


US Politics
Everyone is watching Georgia. Governor Brian Kemp’s decision to allow some nonessential businesses to reopen means business owners (gyms, barber shops, bowling alleys) have to decide if they are confident enough to open for business. Georgia was late to the game in issuing a stay-at-home order and they will be the first state to reopen large parts of their economy.
Immediately, investors will closely watch how many business owners move forward in opening up, how many employees show up for work and whether consumers are comfortable to go back to stores. The
spread of COVID-19 might take up to two weeks, so if cases spike then, this will likely push back other governors in easing lockdown measures..

The UK may be heading for its sharpest contraction in more than a century, with the lockdown still having at least a couple of weeks to go and easing measures likely to be very gradual thereafter. The PMI data this week was horrific but the same is true everywhere. The all-important services sector unsurprisingly shrank at a phenomenal pace, leaving the 35% contraction estimates last week looking perfectly feasible. On the bright side, the trend of new cases and deaths is looking promising.

Italy is continuing on a positive trajectory and some small shops are starting to reopen, coming as a relief to the huge number of SME’s in the country. It comes with strict conditions and the lack of tourism and cautious consumer behaviour means it’s going to continue to be extremely tough, but it’s a crucial first step after weeks of lockdown.

The country is continuing to see cases and deaths broadly move in the right direction, although the last few days has seen slightly increasing cases while deaths have been broadly stable. The government is taking a very cautious approach, warning this week that they are aiming to ease lockdown measures in the second half of May. The country has the second highest number of confirmed cases behind the US and imposed among the most strict lockdown measures.

European Union
EU leaders underwent more painful negotiations this week as they work towards a recovery package for the bloc, estimated to be around €1 trillion. That may sound promising, except the leaders ended the meeting agreeing to leave the details for a future meeting. We all know how that’s going to go. Once again we’re seeing the drawbacks of a group of countries that have different ideas of what a union actually is, wasting time trying to agree on that and responding slowly to the actual crisis at hand.

The ECB loosened restrictions on its collateral requirements this week, allowing for assets that have been downgraded to junk since 7 April, as long as they remain in the upper tier (two notches into junk). The move eases pressure on banks to ensure they continue to have access to the central banks liquidity operations and lend to boost the economy. Further measures may be announced but nothing specific is expected from the ECB meeting next week, with many central banks increasingly making decisions in emergency meetings when necessary. That said, this may set a precedent on willingness to accept junk debt for its operations, which may encourage some tweaking to other bond buying programs at the meeting in order to further ease conditions.

The CBRT exceeded expectations, cutting rates by 100 basis points this week, adding to measures last week to mitigate the economic impact. The central bank claimed the inflation outlook is favourable, citing
weaker commodity prices even as the currency plunges back towards the depths of August 2018 against the dollar.

Following Friday’s 50 basis points rate cut, the Russian central bank seems poised to continue cutting rates further. The CBR GDP forecast sees the economy shrinking by 4-6% and Governor Nabiullina will likely ramp up stimulus efforts at the next policy meeting.
The Russian central bank’s forecast for oil only to rebound to $25 in the fourth quarter suggests a much slower economic recovery is now being priced in and that supports calls for more aggressive action by the CBR.

South Africa
South African President Cyril Ramaphosa has announced that lockdown measures will be eased starting on 1 May, with economic concerns driving the decision. The country has imposed severe restrictions on movement and work over the last month and while many will remain in place or only be eased slightly, it marks a significant change. The country is among those extremely vulnerable to the economic fallout, having already been suffering prior to the spread. Time will tell whether this is a risk worth taking or just premature.

China releases Industrial Profits on Monday 27th and the more important official Manufacturing and Non- Manufacturing PMI’s on Thursday 30th. Both sets of data are expected to disappoint, so a better then expected print could see a substantial jump in Mainland markets.
China continues to keep a lid on a secondary (most imported) wave of COVID-19 cases. Predominantly Chinese returning from Russia. A sharp increase will be negative for markets that are banking on peakvirus being near.

Hong Kong
Balance of Trade on Monday. Exp at HKD-71 billion.
HKMA has been intervening to buy US Dollars at the lower end of the band as rate differentials cause HKD to appreciate. Highly highly unlikely peg breaks. Worries mostly political with arrects of protest leaders, rhetoric from China saying basic law doesn’t apply and personnel changes in Government. All will weigh on investor sentiment.

No significant data. Lockdown extended and tightened until the end of May. More fiscal stimulus from the government.
Tightened COVID-19 “circuit-breaker” restrictions continue for the 3rd week, most of the economy that can is working from home. A huge increase in COVID-19 cases has occurred this week from worker dormitories. The headline numbers look terrible but it is actually planned for and under control. The
lockdown extension is more worrying with the economy now deep in recession and the REIT market under serious pressure. Potential downside for SIngapore stocks if bankruptcies increase..

No significant data next week.
Attention remains focused on the number of COVID-19 cases and a timetable for the easing of lockdown restrictions that were recently extended. Social unrest concerns are elevated. The worst is yet to come for India in all likelihood.

Inflation Wednesday and New Home Sales on Friday. Closed for ANZAC Day Monday.
The AUD has risen 8.0% this month, and the ASX 200 by 5% this month. Currency consolidated gains but equities have faded along with US ones. Acutely vulnerable to resource price fears, lower oil and poor China data next week.

New Zealand
Balance of Trade due Wednesday with ANZAC Day holiday this Monday. Level 4 lockdown finishes nationally on Tuesday after acceptable COVID-19 progress.
NZD has rallied 3.50% this month, and the stock market by a huge 12.50% on “peak-virus” and a potential China recovery. Disappointments on either front leave the NZD vulnerable to an aggressive downward reversal although level 4 exit is supportive as the country goes back to work.

Tuesday BoJ rate decision, Thursday Retail Sales and Industrial Production, Friday April Manufacturing PMI.
A heavy data week but the BoJ rate decision is the main event. Rates expected to be unchanged but high change BoJ cancels JGB buying limits ann expands QE programme to support Govt. fiscal stimulus. JPY should weaken although equities should outperform.


With tank tops almost being reached, energy traders will focus on production cuts. The upcoming week focuses on critical earnings from many major oil companies. BP reports on Tuesday. Valero and Diamond Offshore provide results on Wednesday. Thursday will have updates from Shell, Total, and ConocoPhillips. Friday will draw special attention with earnings results from Chevron and Exxon. Exxon has been one of the more resistant oil majors to rally behind others in participating with production cuts.
Oil prices have been stabilizing, but the OPEC + production cuts that take effect in May still fall several million barrels short of making up the demand shortfall. OPEC + and the Texas Railroad Commission (oil
regulator) will likely debate deeper coordinated production cuts over the next week, with possibly a coordinated announcement happening by May 5th.

Gold continues to benefit from global stimulus. Gold will likely see steady support from intensifying efforts by central banks that will expand their balance sheets and as governments continue to deliver regular spending aid. This big mix of stimulus seems to be the backbone argument for gold prices to run to the $2,000 an ounce level.
Gold volatility remains on high, especially to the downside as the bullish bets become overcrowded. Gold could see a lot of the bulls rush to the exits if one of the several vaccines that is phase one clinical trials, but that won’t happen for at least a month.

Bitcoin is starting to show signs of life ahead of its May 12th halving event and as central banks all over the world continuing to unveil fresh stimulus measures. Bitcoin appears to have found a new wave of retail interest that is firmly believing the macro fundamentals support a much higher valuation. Bitcoin’s recent rebound stemmed from expectations that central banks’ stimulus efforts all over the world will not slow down.
Volatility is about to pick up as the halving event will either be the key catalyst for Bitcoin to soar as it has with the prior two other halving moments or if the surge has already been priced in and this will be used as an excuse to sell it.

Key Economic Releases and Events:

Sunday, April 26th
Japan Lower House by-election in Shizuoka Prefecture
New Zealand and Australian banks will be closed in observance of Anzac Day

Monday, April 27th
UK PM Johnson expected to return to work
Bank of Japan (BOJ) Interest Rate Decision: Expected to increase stimulus efforts, may announce unlimited bond purchases

Tuesday, April 28th
Japanese banks will be closed in observance of Showa Day
BP, Caterpillar, and Alphabet earnings
8:00am Hungary Central Bank Interest Rate Decision: No change in policy expected (announced bond purchases at April 7th intra-policy meeting)
10:00am US April Consumer Confidence: 90e v 120 prior
9:30pm AUD Q1 CPI Q/Q: 0.2%e v 0.7% prior; Y/Y: 2.0%e v 1.8% prior

Wednesday, Apr 29th
8:30am US Q1 Advance GDP Annualized Q/Q: -3.7%e v 2.1% prior; Personal Consumption: -1.3%e v 1.8% prior, GDP Price Index: 0.9% v 1.3% prior, Core PCE Q/Q: No est v 1.3% prior
10:00am US Mar Pending Home Sales M/M: -10.0%e v 2.4% prior
2:00pm US FOMC Rate Decision: Expected to keep target range unchanged at 0.00-0.25%
2:30pm US Fed Chair Powell holds post-FOMC meeting press conference
9:00pm China Apr Manufacturing PMI: 51.0e v 52.0 prior; Non-Manufacturing PMI: 52.8e v 52.3 prior
9:00pm New Zealand Apr Final ANZ Business Confidence: No est v -73.1 prior

Thursday, Apr 30th

Amazon and Apple earnings after the close
1:30am France Q1 Preliminary GDP Q/Q: -4.0%e v -0.1% prior; Y/Y: -3.1%e v 0.9% prior
3:00am Spain Q1 Preliminary GDP Q/Q: -4.4%e v 0.4% prior; Y/Y: -2.9%e v 1.8% prior
3:55am Germany Apr Unemployment Change: 50.0K v 1.0K prior
5:00am Euro Zone Q1 Advance Q/Q: -3.9%e v 0.1% prior; Y/Y: -3.4%e v 1.0% prior
5:00am Euro Zone Apr Preliminary CPI M/M: 0.2%e v 0.5% prior; Y/Y: 0.1%e v 0.7% prior
7:45am EUR ECB Interest Rate Decision: Expected to keep interest rates unchanged
8:30am EUR ECB Press Conference
8:30am US Jobless Claims: 3.5Me v 4.43M prior; Continuing Claims: No est 15.98M prior
8:30am CAD Canada Feb GDP M/M: 0.0%e v 0.1% prior; Y/Y: 1.7%e v 1.8% prior
9:45am US Chicago PMI: 40.0e v 47.8 prior

Friday, May 1st
May Day holiday for many countries
10:00am US Apr ISM Manufacturing: 37.5e v 49.1 prio

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Spread & Containment

Will Powell Pivot? Don’t Count On It

Stocks are rallying on hopes that Jerome Powell and the Fed will stop increasing interest rates this fall, pivot, and start reducing them next year. For…



Stocks are rallying on hopes that Jerome Powell and the Fed will stop increasing interest rates this fall, pivot, and start reducing them next year. For fear of missing out on the next great bull run, many investors are blindly buying into this new Powell pivot narrative.

What these investors fail to realize is the Fed has a problem. Inflation is raging, the likes of which the Fed hasn’t dealt with since Jerome Powell earned his law degree from Georgetown University in 1979.  

Despite inflation, markets seem to assume that today’s Fed has the same mindset as the 1990-2021 Fed. The old Fed would have stopped raising rates when stocks fell 20% and certainly on the second consecutive negative GDP print. The current Fed seems to want to keep raising rates and reducing its balance sheet (QT).

The market-friendly Fed we grew accustomed to over the last few decades may not be driving the ship anymore. Yesterday’s investment strategies may prove flawed if a new inflation-minded Fed is at the wheel.

Of course, you can ignore the realities of today’s high inflation and take Jim Cramer’s ever-bullish advice.

When the Fed gets out of the way, you have a real window and you’ve got to jump through it. … When a recession comes, the Fed has the good sense to stop raising rates,” the “Mad Money” host said. “And that pause means you’ve got to buy stocks.

Shifting Market Expectations

On June 10, 2022, the Fed Funds Futures markets implied the Fed would raise the Fed Funds rate to 3.20% in January 2023 and to 3.65% by July 2023. Such suggests the Fed would raise rates by almost 50bps between January and July.

Now the market implies Fed Funds will be 3.59% in January, up .40% in the last two months. However, the market implies July Fed Funds will be 3.52%, or .13% less than its January expectations. The market is pricing in a rate reduction between January and July.

The graph below highlights the recent shift in market expectations over the last two months.

The graph below from the Daily Shot shows compares the market’s implied expectations for Fed Funds (black) versus the Fed’s expectations. Each blue dot represents where each Fed member thinks Fed Funds will be at each year-end. The market underestimates the Fed’s resolve to increase interest rates by about 1%.

Short Term Inflation Projections

The biggest flaw with pricing in predicting a stall and Powell pivot in the near term is the possible trajectory of inflation. The graph below shows annual CPI rates based on three conservative monthly inflation data assumptions.

If monthly inflation is zero for the remainder of 2022, which is highly unlikely, CPI will only fall to 5.43%. Yes, that is much better than today’s 9.1%, but it is still well above the Fed’s 2.0% target. The other more likely scenarios are too high to allow the Fed to halt its fight against inflation.

cpi inflation

Inflation on its own, even in a rosy scenario, is not likely to get Powell to pivot. However, economic weakness, deteriorating labor markets, or financial instability could change his mind.

Recession, Labor, and Financial Instability

GDP just printed two negative quarters in a row. Some economists call that a recession. The NBER, the official determiner of recessions, also considers the health of the labor markets in their recession decision-making. 

The graph below shows the unemployment rate (blue), recessions (gray), and the number of months the unemployment rate troughed (red) before each recession. Since 1950 there have been eleven recessions. On average, the unemployment rate bottoms 2.5 months before an official recession declaration by the NBER. In seven of the eleven instances, the unemployment rate started rising one or two months before a recession.

unemployment and recession

The unemployment rate may start ticking up shortly, but consider it is presently at a historically low level. At 3.5%, it is well below the 6.2% average of the last 50 years. Of the 630 monthly jobs reports since 1970, there are only three other instances where the unemployment rate dipped to 3.5%. There are zero instances since 1970 below 3.5%!

Despite some recent signs of weakness, the labor market is historically tight. For example, job openings slipped from 11.85 million in March to 10.70 in June. However, as we show below, it remains well above historical norms.

jobs employment recession

A tight labor market that can lead to higher inflation via a price-wage spiral is of concern for the Fed. Such fear gives the Fed ample reason to keep tightening rates even if the labor markets weaken. For more on price-wage spirals, please read our article Persistent Inflation Scares the Fed.

Financial Stability

Besides economic deterioration or labor market troubles, financial instability might cause Jerome Powell to pivot. While there were some growing signs of financial instability in the spring, those warnings have dissipated.  

For example, the Fed pays close attention to the yield spread between corporate bonds and Treasury bonds (OAS) for signs of instability. They pay particular attention to yield spreads of junk-rated corporate debt as they are more volatile than investment-grade paper and often are the first assets to show signs of problems.

The graph below plots the daily intersections of investment grade (BBB) OAS and junk (BB) OAS since 1996. As shown, the OAS on junk-rated debt is almost 3% below what should be expected based on the robust correlation between the two yield spreads. Corporate debt markets are showing no signs of instability!

corporate bonds financial stability

Stocks, on the other hand, are lower this year. The S&P 500 is down about 15% year to date. However, it is still up about 25% since the pandemic started. More importantly, valuations have fallen but are still well above historical averages. So, while stock prices are down, there are few signs of equity market instability. In fact, the recent rally is starting to elicit FOMO behaviors so often seen in speculative bullish runs.

Declining yields, tightening yield spreads, and rising asset prices are inflationary. If anything, recent market stability gives the Fed a reason to keep raising rates. Ex-New York Fed President Bill Dudley recently commented that market speculation about a Fed pivot is overdone and counterproductive to the Fed’s efforts to bring down inflation.

What Does the Fed Think?

The following quotes and headlines have all come out since the late July 2022 Fed meeting. They all point to a Fed with no intent to stall or pivot despite its effect on jobs and the economy.

  • Fed’s Kashkari: concerning inflation is spreading; we need to act with urgency
  • St. Louis Fed President James Bullard says he favors a strategy of “front-loading” big interest-rate hikes, repeating that he wants to end the year at 3.75% to 4% – Bloomberg
  • “If you have to cut off the tail of a dog, don’t do it one inch at a time.”- Fed President Bullard
  • “There is a path to getting inflation under control,” Barkin said, “but a recession could happen in the process” – MarketWatch
  • The Fed is “nowhere near” being done in its fight against inflation, said Mary Daly, the San Francisco Federal Reserve Bank president, in a CNBC interview Tuesday.  –MarketWatch
  • “We think it’s necessary to have growth slow down,” Powell said last week. “We actually think we need a period of growth below potential, to create some slack so that the supply side can catch up. We also think that there will be, in all likelihood, some softening in labor market conditions. And those are things that we expect…to get inflation back down on the path to 2 percent.”


We are highly doubtful that Powell will pivot anytime soon. Supporting our view is the recent action of the Bank of England. On August 4th they raised interest rates by 50bps despite forecasting a recession starting this year and lasting through 2023. Central bankers understand this inflation outbreak is unique and are caught off guard by its persistence.

The economy and markets may test their resolve, but the threat of a long-lasting price-wage spiral will keep the Fed and other banks from taking their foot off the brakes too soon.

We close by reminding you that inflation will start falling in the months ahead, but it hasn’t even officially peaked yet.

The post Will Powell Pivot? Don’t Count On It appeared first on RIA.

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Market Rally Has Some High Hurdles To Clear  

One of the most exciting races in all of track and field is the 110-meter-high hurdles, a fierce event that requires extreme focus, grit and determination…



One of the most exciting races in all of track and field is the 110-meter-high hurdles, a fierce event that requires extreme focus, grit and determination to succeed in clearing all 10 hurdles without hitting one, which can easily compromise victory.

Back in 1981, Renaldo “Skeets” Nehemiah owned the track and field world as the first man to run the 110m hurdles under 13 seconds, clocking a 12.93. As a member of the Virginia Tech University Track & Field team during 1981 (Class of 1982), I had the privilege of meeting Skeets in the infield at an all-conference meet at Florida State University stretching out before the men’s 880-yard relay.

He had already torched the field in the 110 highs and was going to run the anchor leg for the Terrapins in the 880 relay. As I watched him take the baton, it was if his feet never touched the ground. He ran his leg in 19 seconds flat, an unofficial world record time for a 220 split.

It is always fun to share a memory about meeting someone who is very special and very humble, but it also makes for an abstract metaphor by which to compare to what I believe the market faces in the next several weeks ahead — a series of high hurdles to clear before it gets to what could well be the year-end handoff to a record-setting finish.

Not only did the market put up a good fight to avoid dipping below its lows in June, it made up a decent portion of year-to-date losses during the month of July. Led by the all-important big-cap technology sector, growth stocks came back into fashion as the expectations of reduced inflation and fewer rate hikes took hold of investor sentiment.

The latest stronger-than-forecast data from the labor market and manufacturing sector has the Atlanta Fed raising its gross domestic product (GDP) estimate to 1.4% from the -1.9% that I posted just a week ago in this column. That’s a notable swing of 3.3% to the good! And, with over 80% of S&P 500 companies having posted second-quarter sales and earnings that exceeded estimates, the market found some good footing upon which to build.

The first hurdle that will heavily impact market sentiment will be when the Consumer Price Index (CPI) and Producer Price Index (PPI) reports for July are released. While food and energy prices have come down, the costs of rent, professional services and skilled and hourly workers have probably increased. The market has been betting heavily of late that inflation has peaked, where any numbers that come in above consensus will take bond yields higher and stock prices lower as expectations of more Fed interest rate hikes will likely hurt investor sentiment. There is an important week ahead.

Investors shouldn’t be complacent about the market’s newfound lovefest with the change in narrative about the economy skirting a recession. There are deep problems in other major economies around the world. While inflationary forces in the United States will likely begin to diminish as the year progresses, the same cannot be said for Europe, which faces stubbornly high prices for natural gas, food and other shortages.

Europe is facing a grim winter of record inflation, if there is no relief in the price of natural gas. Russia has now stated it is slashing the supply of gas through the Nord Stream 1 pipeline to just 20% of capacity to pressure Germany and the European Union (EU) to stand down in their support of Ukraine. Top EU officials say Russia is “blackmailing” Europe and “weaponizing” its gas supplies. Moscow has repeatedly denied the accusations.

Japan’s economy is the third-largest in the world and faces the same challenges of inflation and a weakening global economy that could pressure its export-dependent economy. Japan is adding an additional $2 trillion to its mountain of debt, now at 230% of GDP. That percentage of debt to GDP is the highest in the world. The Bank of Japan has almost no choice but to keep bond rates low to be able to service debt. But as a result, the yen has lost more than 20% of its value in the past year.

For decades, the yen was considered a safe-haven currency, but now it shows what can happen when a nation’s debt soars to where it compromises the currency in a country that faces an aging society, a declining birthrate, labor shortages and highly restrictive immigration laws. Supply chain snarls and more bouts of COVID-19 only compound a very difficult set of economic conditions.

China has its own set of stiff headwinds. Its slumping property market and shadow banking industry are under serious stress, with the government having to orchestrate broad refinancing measures to avoid widespread bankruptcies. The country will be hard pressed to meet its year-end GDP goal of 5.5% if it continues to wage full lockdowns against COVID outbreaks. Data showed the world’s second-largest economy slowed sharply in the second quarter, missing market expectations with just a 0.4% increase from a year earlier.

And capital outflows from Chinese bonds and equities continued for a sixth straight month with the United States threatening to delist major Chinese ADRs due to regulatory and disclosure violations. Tensions with the United States due to its support of Taiwan are also a possible flash point that is keeping capital away from those markets. A view of the China Large-Cap iShares ETF (FXI) shows a very troubling pattern where that market could test the 2008 low, marking a 14-year period of stagnant market conditions.

Sadly, Hong Kong, once the shining Asian light where East meets West, has seen its equity market retreat 40% from its 2018 highs after China’s pseudo-takeover. The Hang Seng Index now trades at the same level as in 2007. This week, videos of Chinese tanks on streets to disperse agitators fuming at not being able to withdraw funds from their bank accounts have gone viral as the government now grapples with growing civil unrest. So much for the great China experiment.

And the war in Ukraine only adds further uncertainty to this set of big challenges for the global economy. Because the United States accounts for roughly 25% of total global GDP, it is considered a safe and investible market for now, as economic conditions are stable, while the U.S. dollar and the labor market are strong. This is a big reason capital from around the world is seeking shelter and opportunity in the U.S. bond and equity markets. 

There is still an incredible amount of uncertainty with inflation, interest rates, energy prices, commodity prices and geopolitical situations that could flare up at any time. As some of these metrics become more clear in the month ahead, investors will gain much-needed insight into these and other risks that will determine whether the recent gains will hold and build, or whether another retest of some lower level for the market is in order.

The post Market Rally Has Some High Hurdles To Clear   appeared first on Stock Investor.

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Fed reverse repo reaches $2.3T, but what does it mean for crypto investors?

Investors avoid risk assets during a crisis, but excessive cash sitting in financial institutions could also be good for the cryptocurrencies.



Investors avoid risk assets during a crisis, but excessive cash sitting in financial institutions could also be good for the cryptocurrencies.

The U.S. Federal Reserve (FED) recently initiated an attempt to reduce its $8.9 trillion balance sheet by halting billions of dollars worth of treasuries and bond purchases. The measures were implemented in June 2022 and coincided with the total crypto market capitalization falling below $1.2 trillion, the lowest level seen since January 2021. 

A similar movement happened to the Russell 2000, which reached 1,650 points on June 16, levels unseen since November 2020. Since this drop, the index has gained 16.5%, while the total crypto market capitalization has not been able to reclaim the $1.2 trillion level.

This apparent disconnection between crypto and stock markets has caused investors to question whether the Federal Reserve’s growing balance sheet could lead to a longer than expected crypto winter.

The FED will do whatever it takes to combat inflation

To subdue the economic downturn caused by restrictive government-imposed measures during the Covid-19 pandemic, the Federal Reserve added $4.7 trillion to bonds and mortgage-backed securities from January 2020 to February 2022.

The unexpected result of these efforts was 40-year high inflation and in June, U.S. consumer prices jumped by 9.1% versus 2021. On July 13, President Joe Biden said that the June inflation data was "unacceptably high." Furthermore, Federal Reserve chair Jerome Powell stated on July 27:

“It is essential that we bring inflation down to our 2 percent goal if we are to have a sustained period of strong labor market conditions that benefit all.”

That is the core reason the central bank is withdrawing its stimulus activities at an unprecedented speed.

Financial institutions have a cash abundance issue

A "repurchase agreement," or repo, is a short-term transaction with a repurchase guarantee. Similar to a collateralized loan, a borrower sells securities in exchange for an overnight funding rate under this contractual arrangement.

In a "reverse repo," market participants lend cash to the U.S. Federal Reserve in exchange for U.S. Treasuries and agency-backed securities. The lending side comprises hedge funds, financial institutions and pension funds.

If these money managers are unwilling to allocate capital to lending products or even offer credit to their counterparties, then having so much cash at disposal is not inherently positive because they must provide returns to depositors.

Federal Reserve overnight reverse repurchase agreements, USD. Source: St. Louis FED

On July 29, the Federal Reserve's Overnight Reverse Repo Facility hit $2.3 trillion, nearing its all-time high. However, holding this much cash in short-term fixed income assets will cause investors to bleed in the long term considering the current high inflation. One thing that is possible is that this excessive liquidity will eventually move into risk markets and assets.

While the record-high demand for parking cash might signal a lack of trust in counterparty credit or even a sluggish economy, for risk assets, there is the possibility of increased inflow.

Sure, if one thinks the economy will tank, cryptocurrencies and volatile assets are the last places on earth to seek shelter. However, at some point, these investors will not take further losses by relying on short-term debt instruments that do not cover inflation.

Think of the Reverse Repo as a "safety tax," a loss someone is willing to incur for the lowest risk possible — the Federal Reserve. At some point, investors will either regain confidence in the economy, which positively impacts risk assets or they will no longer accept returns below the inflation level.

In short, all this cash is waiting on the sidelines for an entry point, whether real estate, bonds, equities, currencies, commodities or crypto. Unless runaway inflation magically goes away, a portion of this $2.3 trillion will eventually flow to other assets.

The views and opinions expressed here are solely those of the author and do not necessarily reflect the views of Cointelegraph. Every investment and trading move involves risk. You should conduct your own research when making a decision.

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