Hope all goes well… We fielded so many calls this week on both UST and Coinbase that we decided to publish our analysis/perspective in a market note [click here]. The synopsis: Everyone is asking us. Is stablecoin a systemic risk? No. Are assets at Coinbase secure? Yes. Digital assets are demonstrating resiliency. But market pressures also demand accelerated regulatory clarity. We see regulatory principles being agnostic to technology, embracing those who welcome oversight.
Overall: “We are peering into the curved spacetime near a supermassive black hole,” said Michael Johnson, researcher at the Harvard-Smithsonian Center for Astrophysics, marveling at the image. “And it is teeming with activity, always burbling with turbulent energy and occasionally erupting into bright flares of emission,” added Johnson, standing tall on our little planet, 27,000 light years (159,300 trillion miles) from Sagittarius A*. At this vast distance, we travel through space at 140 miles per second, rotating around the supermassive black hole at our Milky Way’s center. Nearer objects move faster. Stars closest to Sagittarius A* travel at 141,000 miles per second. The plasma surrounding the black hole’s event horizon orbits at 190,000 miles per second, superheats to a trillion degrees, then disappears. Within our galaxy, gravity wins, eventually, always. Or so it seems. Time will tell. Unlike heavenly bodies, financial markets are our creation, and as such, they are just as much a part of nature as are we, which is to say indistinguishable. In financial markets, the strongest known gravitational force is produced by the presence of stop-losses imposed by leverage. The larger the stop, the greater the pull. The natural force at play is easy understand. As the aggregate position size grows too large relative to its ability to withstand a capital loss, the market is drawn toward the price that forces liquidation. As prices approach that level, the process accelerates, the temperature rises. Along that path, the combination of counterparties demanding more margin, nervous longs liquidating, and short sellers pressing positions produces an outcome all but inevitable. We see this repeatedly. Long Term Capital Management was a victim of gravity. So too were VIX ETP volatility-sellers in Feb 2018. The Archegos unwind took two days in Apr 2021. This week a US dollar stablecoin called UST succumbed to gravity. A shockwave rippled across digital asset markets. And with temperatures this elevated, time accelerating, we are left to carefully examine the numerous large stops across the $200 trillion universe of traditional assets.
Week-in-Review (expressed in YoY terms): Mon: Putin not as aggressive as feared during “Victory Day” Red Square speech, Terra stablecoin loses USD peg, China announces complete Shanghai lockdown, India CB intervened to stem currency weakness, Chinese Premier Li Keqiang warned of complicated / grave employment situation as covid restrictions continue to tighten, BoJ minutes showed some members highlighted the need for continued stimulus, G7 leaders pledged to ban Russian oil imports even as Hungary frustrates EU’s bloc wide embargo, oil falls after Saudi Arabia cut oil prices for Asian buyers, Fed’s Bostic does not see need to hike by more than 50bp, China expts 3.9% (2.7%e) / impts 0% (-3%e), EU investor confidence -22.6 (-21.6e), Mexico CPI 7.68% (7.73%e) / Core CPI 7.22% (7.18%e), US wholesale inv 2.3% MoM as exp, S&P -3.2%; Tue: Central African Republic becomes second country to adopt Bitcoin as official currency, Warhol’s Marilyn Monroe portrait sells for record $195m, Chinese state media reported that there is no basis for a substantial weakening of the yuan, Turkey’s Erdogan announced a new govt measure that offers lower mortgage rates for those who convert FX for liras, Fin Min Suzuki said JPY recent rapid decline not desirable, ECB’s Nagel sees APP ending in June and will advocate rate hikes in July, Fed’s Williams thinks good chance Fed can achieve “soft landing”, Fed’s Mester supports 50bp hikes but thinks should not rule out 75bp hikes forever, Turkey unemp 11.5% (11.1%p), US NFIB 93.2 (92.9e), S&P +0.3%; Wed: US CPI 8.3% (8.1%e) / Core CPI 6.2% (6%e), ECB’s Lagarde confirmed July rate hike likely, US house passes $40b aid package to Ukraine (heads to Senate), Dallas Fed names Lorie Logan as new president, Fed’s Bullard reiterates target of 3.5% by year end / supports 50bp hikes but doesn’t rule out 75bp, rumors that Biden is exploring dropping China tariffs to reduce price pressures, Lula talks about rescinding spending cap if he wins Brazils upcoming presidential election, UST stable coin continues to plunge (reaching 0.30), China PPI 8% (7.8%e) / CPI 2.1% (1.8%e), German CPI 7.8% as exp, Brazil IPCA infl 12.13% (12.06%e), S&P -1.7%; Thur: HKMA actively defends USDHKD peg (first time since 2019), N. Korea tests ballistic missile, Finland leaders back an application to join NATO, Russia cut nat gas supplies to German in retaliation, Yellen highlights stablecoin risks amid crypto collapse, Fed’s Daly sees no reason to alter course for 50bp hikes at next 2 mtgs, Powell says 50bp is appropriate for the next two meetings / leaves door open for 75bp at some point, Mexico CB hikes 50bp as exp, Kim Jung Un locks down N. Korea after 1st positive case of covid, Sweden CPIF 6.4% (6.2%e), UK 1Q GDP 8.7% (8.9%e) / IP 0.7% (0.6%e), US PPI 11% (10.7%e) / Core PPI 8.8% (8.9%e), US init claims 203k (193k exp), S&P -0.1%; Fri: CBIRC official says “one way CNY depreciation will not continue over the long term”, goal for Shanghai lockdown to end is 5/20, BoJ’s Kuroda says important to continue to support economy with monetary easing, Russia to increase defense along Finnish border, Musk says TWTR takeover ‘temporarily on hold’, Robinhood stock jumps after Sam Bankman-Fried announces 7.6% stake, digital assets outside of Terra stage a comeback, Turkey’s Erdogan does not support Sweden/Finland joining NATO, US senate failed to past $40b package for Ukraine, Argentina CPI 58% (57.35%e), China new loans 645.4b (1530b exp), China M2 10.5% (9.9%e), US impt prices 12% (12.3%e), US UofM 59.1 (64e) / 1y infl exp 5.4% (5.5%e) / 5-10y infl exp 3% unch, Russia CPI 17.83% (17.99%e), S&P +2.4%.
Weekly Close: S&P 500 -2.4% and VIX -1.32 at +28.87. Nikkei -2.1%, Shanghai +2.8%, Euro Stoxx +0.8%, Bovespa +1.7%, MSCI World -2.2%, and MSCI Emerging -2.6%. USD rose +25.7% vs Ethereum, +16.7% vs Bitcoin, +3.5% vs Turkey, +2.0% vs Australia, +1.8% vs China, +1.3% vs Euro, +1.1% vs South Africa, +1.0% vs Sweden, +0.8% vs Indonesia, +0.7% vs Sterling, +0.7% vs India, +0.4% vs Canada, and +0.2% vs Chile. USD fell -5.2% vs Russia, -1.0% vs Yen, -0.4% vs Brazil, and -0.1% vs Mexico. Gold -4.0%, Silver -6.1%, Oil +0.7%, Copper -2.2%, Iron Ore -2.2%, Corn -0.4%. 5y5y inflation swaps (EU -12bps at 2.19%, US +1bp at 2.74%, JP -13bps at 0.75%, and UK +22bps at 4.08%). 2yr Notes -15bps at 2.58% and 10yr Notes -21bps at 2.92%.
YTD Equity Indexes (high-to-low): Saudi Arabia +13.9% priced in US dollars (+13.8% priced in riyals), Chile +11.9% priced in dollars (+12.6% in pesos), UAE +11.8% in dollars (+11.8% in dirham), Brazil +11.7% (+2%), Turkey +11.3% (+30.2%), Colombia +6.2% (+7.2%), Singapore -1.2% (+2.2%), Indonesia -2.4% (+0.3%), Venezuela -3% (-0.3%), Mexico -5.3% (-6.9%), Norway -6.6% (+3.8%), Malaysia -6.6% (-1.5%), Argentina -6.9% (+6.3%), Canada -7.3% (-5.3%), Thailand -8.3% (-4.4%), Portugal -8.5% (+0.1%), South Africa -8.9% (-7.5%), UK -9.2% (+0.5%), Australia -9.6% (-5%), Greece -11.3% (-2.9%), Spain -12% (-4.3%), India -12.5% (-9.1%), Philippines -12.5% (-10.4%), Israel -14.7% (-5.6%), HK -15.5% (-15%), S&P 500 -15.6%, Czech Republic -16% (-9.1%), Belgium -16.3% (-8.5%), MSCI World -16.4%, Switzerland -17.4% (-9.5%), Japan -18.3% (-8.2%), Korea -18.7% (-12.5%), France -18.7% (-11%), Germany -18.8% (-11.7%), Italy -19.1% (-12.1%), Taiwan -19.3% (-13.1%), Russell -20.2%, Netherlands -20.5% (-13%), China -20.7% (-15.3%), Denmark -20.7% (-13.3%), Euro Stoxx 50 -21.2% (-13.8%), New Zealand -21.7% (-14.3%), Finland -22.3% (-15.6%), Ireland -23.1% (-15.8%), NASDAQ -24.5%, Sweden -25.2% (-16.9%), Austria -26.1% (-19.7%), Poland -28.4% (-20.4%), Hungary -28.5% (-18.7%), and Russia -30.4% (-39.1%).
Stop: As a young pit trader in 1989, I was taught to understand where the big stop-loss orders were likely to be found. Markets in rough balance tend to oscillate, wander. But when there are traders with big leveraged positions, and they do not have the capital to sustain a large move against their exposures, they will eventually be forced to stop out either by choice or by creditors. As prices approach that stop-loss level, the trend accelerates. Sometimes such markets move as much in a minute as they otherwise do in a decade. Spacetime is bent around such stops.
Stop II: Markets are mostly mean reverting. Their ups and downs are nature’s search for equilibrium. The damage to those on the wrong side of stops in such markets goes largely unnoticed in the broader financial system. But sometimes stops are existential. Hitting them precipitates a self-perpetuating move that is never reversed. Companies, currencies, and sovereigns – sometimes all at the same time – experience permanent shifts. And in times of great change, such as this turbulent decade, these are the stops to watch most carefully. Here are some:
Putin: Russia is approaching a stop. Its slow-moving demographic collapse has been known for decades. Its weak economic engine will collapse beneath sanctions, depriving Russia of the capital to sustain itself and defend against domestic and foreign adversaries. NATO membership of Finland and Sweden is the kind of price action you see when nearing a stop. So too, the accelerating pace of Kyiv visits by world leaders and nuclear saber rattling by Russian defense ministers. Were Russia not a great nuclear power, a stop would be hit imminently. But it has 1,500 nuclear warheads currently deployed. This is clearly the world’s greatest near-term risk.
Famine: What appeared to be a trend of ever-expanding globalization allowed world governments and their respective economic systems to optimize for efficiency. But efficiency came at the cost of fragility, dependency. The current commodity price shock, and unfolding food shortage, will devastate most poor nations. This is only just getting started. Indonesia’s plan to limit palm oil exports, and India’s extraordinary decision to ban wheat exports, is what you see as governments approach stops. Hoarding has begun. This is the world’s greatest 2-3yr risk.
Union: Europe is a project that exchanges the constraints of political union for the promise of an end to senseless war. It was not designed for economic efficiency, and it has so far avoided a complete monetary integration. It made an energy deal with Russia that left its economy dependent, vulnerable. It must now overcome an energy crisis, risking direct conflict with Russia. While common enemies tend to draw nations together, the continent has a long history of fracture, infighting. It has also tended to make moves toward greater integration only in times of acute market stress. The market hunts for such stops. The 10yr Germany/Italy spread is 190bps.
America: There is no nation better positioned for a world that is deglobalizing than the US. It is the largest food producer, has enormous energy resources, innovators, capital markets, etc. Such advantages have been sold forward. Foreigners own $53.3trln US assets and the US owns $35.2trln foreign assets. The net external deficit has quietly increased nearly 10x since the start of the 2008 crisis. Our politicians have made entitlement promises that project government debt of more than 200% of GDP in the next thirty years, almost double the current share of GDP. Such vast imbalances will need to be resolved through default or devaluation (inflation). The latter is more likely. Unless the Fed contains inflation aggressively, the market will sniff the stop.
Anecdote: The Sun fuses 600 million tons of hydrogen into helium each second to produce the outward pressure required to offset its gravity. All stable stars live in this state of hydrostatic equilibrium. When their fuel is eventually expended, gravity prevails, and they collapse into themselves, achieving new equilibriums governed by quantum law. Small stars like our Sun become white dwarfs. Larger ones become neutron stars, the densest objects in the visible universe. The most massive stars overcome all know forces and disappear entirely – this collapse to a black hole occurs in less than a second. Spinning here on a little blue planet, 27,000 light years away from the invisible center of our galaxy, the scale and speed of such forces appears less extreme. Yet still, we observe all things around us struggling endlessly, mercilessly, for equilibrium. The weather constantly reminds us that complex systems move in volatile ways as they search for balance. This extends to all natural systems, creatures, companies, nations too. Throughout history our kingdoms, countries, and empires have had to produce sufficient outward pressure to maintain equilibrium and forestall collapse. The most prosperous ones have sustained balance through building vibrant economic systems. Such economies generate surpluses sufficient to sustain investment and finance a robust defense against those who threaten its existence. Some nations succeeded through conquest, confiscation, slavery, savagery. Others through capitalism. There are many models in between. When nations are growing more prosperous, their governments have relatively easy work. But when the economic engine falters, they must make difficult choices to sustain the outward pressure required to avoid collapse. Many governments fail; sustaining a healthy economic system is hard work, requiring foresight, investment, ingenuity, risk-taking. In their failure, such governments resort to coercion, confiscation, crackdowns. They pay their bills and bribe the citizenry with money borrowed against their nation’s future, leaving it diminished, eventually depleted. In a final attempt to defy gravity, and approaching their stop loss, governments print money. And this is why failing nations suffer currency collapse.
Good luck out there,
Chief Investment Officer
One River Asset Management
Disclaimer: All characters and events contained herein are entirely fictional. Even those things that appear based on real people and actual events are products of the author’s imagination. Any similarity is merely coincidental. The numbers are unreliable. The statistics too. Consequently, this message does not contain any investment recommendation, advice, or solicitation of any sort for any product, fund or service. The views expressed are strictly those of the author, even if often times they are not actually views held by the author, or directly contradict those views genuinely held by the author. And the views may certainly differ from those of any firm or person that the author may advise, drink with, or otherwise be associated with. Lastly, any inappropriate language, innuendo or dark humor contained herein is not specifically intended to offend the reader. And besides, nothing could possibly be more offensive than the real-life actions of the inept policy makers, corrupt elected leaders and short, paranoid dictators who infest our little planet. Yet we suffer their indignities every day. Oh yeah, past performance is not indicative of future returns.