Recession, inflation or both? | Finance times

good morning. The latest phase of the sale that led us to a bear market was shocking at speed, but familiar in the structure. More on this and about the intensifying mess in crypto technology below. Send us an email: robert.armstrong@ft.com and ethan.wu@ft.com.

which we taught us two bad days

The inflation report on Friday morning was a surprise. The market's reaction to this was followed by the standard script. In conceptual, if not temporal order, the following happened:

Firstly, the expectations of interest increases have changed significantly. A week ago, the appointment market implied a 3 percent chance of an increase of 75 basis points and a 97 percent chance of an increase of 50 points if the FED meets later this week. Now the odds are 28/72. The Fed Funds Rate for February 2023, implied by the market, rose from 3.1 to 3.9 percent.

Next, the treasury curve moved strongly. The interest rates rise in all terms, but the fastest of two and five years, which flattened the gut of the curve.

Next, the shares fell strongly. The S&P fell 6.8 percent within two days. Everything went back, but Value fell less than growth, and Big Caps fell less than small caps. Here is the sectoral division:

Note the known pattern: The growth title that have developed so well during the Coronavirus pandemic were sold most (the non-basic consumption goods sector is 43 percent weighted on Amazon and Tesla).

We have seen all of this earlier, more or less every time the inflation data come in hot. In fact, most S&P days seem to follow this pattern down. Interest expectations increase, stocks fall, return, the winners of yesterday are becoming the losers of today.

A question remains. Is this an fear of inflation, a fear of recession induced by the Fed or something of both?

The market delivers some useful, if not conclusive, clues. First, Breakeven inflation has not moved much. The great increase in the yield of five -year government bonds, for example, was reflected in the increase in five -year -old inflation -protected government bonds (tips), which means that the implicit inflation remained unchanged:

We have argued in the past that the returns of drinking money are probably a distorted indicator of investors' expectations. Nevertheless, this diagram will probably tell you something, at least in the direction of. It could mean: "The Fed will increase interest rates, but inflation will not be out of control." Or it could mean: "Inflation volatility is increasing, so real interest rates have to rise to reflect this risk." It is probably something of both. But either way, it doesn't scream that inflation gets higher.

Next, look at the returns from corporate bonds towards government bonds. They moved higher, in a certain way. The range between the spreads has increased. This means that the spreads of less quality bonds increase faster than those of higher quality bonds.

Below is the difference between investment grade spreads and spreads only the lowest level of investment grade or BBBS; the difference between BBB and the highest rating of junk bonds or individual BS; and between individual BS and the lowest class of scrap, from CCCS:

If the spread between the spreads is so extensive, it means that the economy will deteriorate and the defaults of payment will increase. This data only goes until Friday, but a reliable Bond Trader contact said that these gaps increased.

Both points indicate that the market is primarily afraid that the FED will tighten the economy into a recession instead of fear that inflation will get out of control. But on the other hand, if inflation was not a reason to worry, you could expect the 10-year government bonds to intercept a bid instead of selling hard. And they would not expect Fed fund futures to rise so much. So the picture is mixed. Recession is the main risk, but also the probability of a recession with high inflation - stagflation - increases.

Things Break again and again in crypto

A month ago, falling crypto prices led to a badly designed stable coin, terrausd. It was one of the most popular projects in decentralized finance - blockchain response to the financial services industry. The capital began to flee from Defi. The fear of inflation on Friday further increased crypto sale. Yesterday something broke:

Binance stopped Bitcoin on Monday for several hours after the crypto loan Celsius also prevented customers from lifting funds from its platform, citing "extreme market conditions". . .

Celsius is one of the largest players on the market for digital yield products and offers users the opportunity to give their tokens as security for other crypto projects. In return for lending their tokens, retailers were able to achieve annual returns of up to 17 percent. . .

The value of the assets stored on the platform of Celsius shrank from more than $ 24 billion to less than $ 12 billion on May 17th.

Celsius is a (centralized) crypto-lending service-i.e. an unregulated bench for speculators and market makers. His capital comes from crypto interludes, which are attracted by the promise of double-digit returns. These deposits are then awarded to dealers.

In good times, people like to earn 17 percent return, but now the times are bad. Celsius didn't seem to have had enough money to make all repayments, so it stopped. In other words, Celsius is cash flow insolvent. A widespread note of Monday claimed that he could end the funds in five weeks.

This could be important beyond Celsius. It invests comprehensively in Defi. Larry cermak at the block Estimates Defi protocols and cryptocurrencies. The company behind Tether also granted Celsius a loan that is secured in Bitcoin. In April, Celsius bragged about 150,000 Bitcoin, a larger proportion than even Michael Saylors Microstrategy. When Celsius fails, Crypto will get several hard blows in the face.

Meanwhile,

had a three-hour failure, the largest crypto exchange, around the same time when the Celsius messages were released. As in the past, the stock exchange was responsible for technical problems.

Katie Martin from the FT believes that even more could happen. Yesterday she made us aware that we may have joined the "Who stays the baby phase of the cryptocrisy"? This means that the crash has developed from the violation of crypto owners to a threat to crypto institutions.

Is your suspicion right? A real crisis could develop if Binance et al. are exposed to a significant hidden risk of falling prices, perhaps through defi investments. Apart from that, the value of the stock exchanges simply depends on the trading volume, which has decreased sharply since 2021. The Coinbase share has fallen by 85 percent since the IPO, because it is a volatile business that is currently shrinking, not because it is so facing a Celsius-like liquidity crisis. The chances are good that the stock exchanges last as long as people want to pay fees for trading with crypto.

A cascading crisis that takes the greatest crypto institutions is possible. Crises reveal hidden risks. But take another option: that many crypto companies fail, but the most important not, small investors without recourse have to accept huge losses and the crypto-boom-bust cycle is repeated. It has happened before. ( ethan wu )

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