Duet Protocol Global Capital Market Weekly Recap & Outlook — 20230529

Duet Protocol
13 min readMay 29, 2023

Hi Dueters,

Welcome to this week’s Duet Protocol Global Capital Market Recap & Outlook. We hope you enjoyed your week and will try your trading skills at Duet Pro.

Here are some of the key points and trends in this week’s market talk:

Market Recap: The debt ceiling crisis continued to trouble the market at the beginning of last week. However, significant progress was made later on, as Nvidia’s better-than-expected earnings report sparked a chase for core technologies such as AI and chips, resulting in a major surge in the US stock market. Defensive assets, on the other hand, experienced a decline as funds concentrated in the technology sector.

Economic Indicators: PMI data showed a divergence in May’s economy, with the service industry remaining strong and the manufacturing sector rebounding. Durable goods sales and PCE reflected persistent inflation, indicating a robust economy and causing expectations for a rate hike in June to soar, while expectations for rate cuts this year vanished.

Cryptocurrency Market: Driven by the extreme optimism in the technology sector, the cryptocurrency market also rebounded. However, the expectation of a rise in terminal interest rate and the anticipation of the TGA withdrawing market liquidity and persistently regulatory crackdown set a resistance for its sustainability.

Debt Ceiling Negotiations: US President Biden and House Speaker McCarthy reached a budget agreement in principle to raise the debt ceiling for 19 months. Market attention has now shifted to the votes in the House and Senate on Wednesday and Friday, respectively. With funds expected to run out by Friday, the voting process MUST go smoothly.

Opinions: The period from June to August is a critical time window as four major contradictions will become very apparent. These include the issuance of new national debt, extreme polarization in the stock market, the Federal Reserve raising interest rates further, and the strong attractiveness of fixed income to capital. The development of AI is expected to reduce investors’ reliance on interest rate path. Valuations are already high but not unreasonable, and there is still room for the bubble phase to continue. Optimism is likely to spread to the cryptocurrency market as both industries, unlike matured industries, have enormous adoption potential. However, the gains in the cryptocurrency market may be limited by concerns over liquidity and regulation hanging over the industry.

Weekly Market Overview:

Last week, global stock markets showed divergent trends as negotiations to raise the US debt ceiling made progress and optimism surrounding artificial intelligence (AI) grew. The US and Japanese stock markets posted strong gains, while European markets initially rebounded on Friday but ended the week with declines. The Chinese stock market experienced weakness throughout the week and closed lower.

In the US stock market sectors, AI undoubtedly emerged as the hottest theme of the week. The technology sector surged over 5%, while the communication sector rose over 1%. However, defensive sectors such as essential goods and materials lagged behind, both declining by over 3%. This indicates that funds continued to move away from defensive assets and shifted towards industries with higher growth potential.

Last week, robust economic data and the hawkish comments from central bank officials sounded the alarm bells for interest rate expectations, as people realized that inflation would remain sticky for a longer period of time. This resulted in a continued climb in US Treasury yields:

  • The 30-year Treasury yield breached the 4% level, reaching the highest level since the end of last year.
  • The 10-year Treasury yield rose from 3.66% to 3.81%, and the 2-year Treasury yield increased from 4.24% to 4.57%, both hitting the highest levels since March of this year.
  • The short-term Treasury yields, such as the 1-month and 3-month, experienced a slight decline, indicating a reduced market concern over the debt ceiling risk.

US crude oil rose by 1.2% to $72.67 per barrel as major oil-producing countries released conflicting information regarding future supply adjustments.

Spot gold prices saw a slight increase of 0.33% to $1,946.69 per ounce. This was primarily due to a cooling down of the debt ceiling negotiation crisis and market speculation of another interest rate hike by the Federal Reserve, which reduced the demand for safe-haven assets like gold. The rise in real interest rates also negatively impacted interest-free assets such as gold, which theoretically could create potential pressure on the price of BTC.

CFTC futures positions:

In general, the net long positions of US stocks (Asset Manager + Leveraged Funds) saw a slight increase last week. However, there was a notable divergence among the three major stock indices. The net long positions for the Nasdaq reached their highest level since early 2022, while the net long positions for the S&P 500 decreased slightly. The net short positions for the Russell 2000 saw a significant reduction and are now almost back to neutral. These changes in positions align with the trends in the cash market.

In the bond market, net short positions have increased to nearly record-high levels. Net short positions for the 2-year, 5-year, and 10-year bonds have risen, while net short positions for the 30-year bonds have declined.

In the foreign exchange market, net short positions on the US dollar have slightly decreased, primarily due to a slight reduction in net long positions on the euro.

Global Equity Fund Flows:

EPFR Data: As of the week ending on the 24th, global equity funds continued to experience net outflows, with a net outflow of -$4 billion USD. This shows some improvement compared to the previous week’s net outflow of -$8 billion USD. Developed market equity funds dominated the outflow of funds, with US equity funds experiencing outflows for the sixth consecutive week, although the magnitude of outflows significantly slowed compared to the previous week. Emerging market equity funds also saw net outflows.

Debt Ceiling Negotiations:

US President Biden and House Speaker McCarthy have reached a budget agreement in principle to raise the debt ceiling for 19 months, until May 18, 2025. As the agreement represents a compromise, any compromise proposal is almost certain to face opposition from both the far left and far right, so market attention has shifted to this week’s votes in the House and Senate.

The leaders of both parties currently express confidence that the debt ceiling agreement will pass. The bill requires 218 votes to pass in the House and 51 votes in the Senate. President Biden strongly urges both chambers of Congress to immediately pass the US debt agreement, and he expects no circumstances that could undermine the agreement. McCarthy claims that 95% of the party’s lawmakers are “excited” about the agreement but acknowledges that the bill “doesn’t have everything everyone wants, but in a divided government, this is what we end up with.”

Treasury Secretary Yellen has updated the date when government funds are expected to run out to June 5th (four days later than the original estimate) and urges Congress to reach a negotiation result as soon as possible to avoid a debt default.

It is expected that the Senate will vote on the bill on Wednesday, and the House could vote as early as Friday. Since Friday is the Treasury’s projected last cash-exhaustion date, the process this week must proceed flawlessly. Although the likelihood of accident derailing the bill’s passage seems small at present, any unexpected occurrences during the voting process that push the passage date beyond the X-Date and into next week would increase market uncertainty.

Key Economic Data from Last Week:

The most influential economic data released on Friday were the Personal Consumption Expenditures (PCE) Price Index and Durable Goods Sales, which had a significant impact, indicating persistent inflation and a resilient economy, raising expectations of a rate hike in June.

In April, the PCE index rose by 0.4% on a month-over-month basis, exceeding expectations of 0.3% and the previous month’s 0.1%. On a year-over-year basis, it increased by 4.4%, also surpassing expectations of 4.3% and the previous month’s 4.3%. The core PCE index, which excludes food and energy, also rose by 0.4% on a monthly basis, surpassing expectations of 0.3% and the previous month’s 0.3%. On a year-over-year basis, it increased by 4.7%, surpassing expectations of 4.6% and the previous month’s 4.6%.

Clearly, this data indicates persistent inflation. Despite the Federal Reserve raising interest rates by 125 basis points since December of last year, the core PCE index has remained around 4.7% without declining. This data further supports expectations of future rate hikes by the Federal Reserve.

Immediately following the release of the data, CME interest rate futures priced in a 70% probability of a rate hike at the next FOMC meeting, compared to only 17% the previous week. This means that the market had previously believed there would be a pause in rate hikes, but last Friday, the expectations shifted to continued rate hikes.

In the upcoming weeks, there are several important data releases, including the non-farm payrolls and CPI reports for May. If either of these reports shows strong performance, the hope for a pause in the June and July meetings will diminish further. Considering that consumers will be traveling more frequently during the summer, this will further boost consumption and stimulate inflation.

In addition to inflation, the data from last Friday also showed growth in US personal income and consumer spending. Income increased by 0.4% on a month-over-month basis, exceeding the previous month’s 0.3%. Consumer spending, on the other hand, experienced a significant increase of 0.8%, compared to only 0.1% in the previous month. On the service side of consumption, it was driven by financial services, insurance, and healthcare, while on the goods side, it was led by new car sales and pharmaceuticals.

On another note, the savings rate decreased once again, dropping from 4.5% to 4.1%, further confirming the sustained high consumer confidence among Americans.

Speaking of strong consumer activity, the Durable Goods report on Friday also reflected similar results. Durable goods sales increased by 1.1% on a month-over-month basis in April, while expectations were for a decline of 0.8%. The month-over-month increase for March was also revised upward by 0.1% to 3.3%. The surge in March was mainly driven by a large order from Boeing. However, if military equipment and aircraft are excluded, durable goods sales showed a decline, but the April data showed a solid rebound. Excluding military equipment and technology, durable goods sales increased by 1.4% on a month-over-month basis, significantly surpassing the 0.6% decline in March and the 0.2% decline in February. The manufacturing sector, which accounts for the largest share, saw a month-over-month increase of 1.7%, while machinery sales rose by 1.0%, and automotive and parts sales only declined by 0.1%.

Other Key Data from Last Week:

The final reading of the University of Michigan Consumer Sentiment Index for May increased to 59.2, surpassing the preliminary reading of 57.7.

The initial jobless claims in the United States came in at 229,000, lower than the expected 245,000, with the previous figure revised to 225,000. For the week ending May 13th, the continuing jobless claims stood at 1.794 million, below the expected 1.8 million, with the previous figure at 1.799 million.

The annualized quarter-over-quarter real GDP growth for the first quarter in the United States was revised from 1.1% to 1.3%. PCE annualized QoQ was revised from 3.7% to 3.8%, while the core PCE annualized QoQ was revised from 4.9% to 5%.

The preliminary Markit Manufacturing PMI for May in the United States was 48.5, lower than the expected 50, with the previous figure at 50.2. The preliminary Services PMI was 55.1, higher than the expected 52.5, with the previous at 53.6. The Composite PMI stood at 54.5, surpassing the expected 53, with the previous at 53.4.

This week’s focus:

Monday: Memorial Day in the United States and Spring Bank Holiday in the United Kingdom — Stock markets in both countries are closed.

Tuesday: US Consumer Confidence Index for May.

Wednesday: Debt ceiling vote in the House of Representatives.

Thursday: US ADP Employment Report for May.

Friday: US Nonfarm Payrolls for May (consensus indicates a gradual cooling in the labor market), and debt ceiling vote in the Senate.

Earnings reports in the US include HP on Tuesday, Salesforce, C3.AI, Chewy on Wednesday, Dollar General, Macy’s, Bilibili, lululemon, and Dell on Thursday.

Our Comment:

The period from June to August is a critical time window, as four major contradictions will become particularly evident (we will focus on the United States here, while future articles will cover more topics such as Japanese monetary policy, European inflation, and China’s progress).

Contradiction 1:

Currently, market expectations are that approximately $500–700 billion of new government bonds will be issued within three months after reaching a debt ceiling agreement. This represents a negative liquidity drain and is expected to marginally suppress the performance of risk assets.

Possible sources of funds to absorb the issuance of new government bonds include money market funds and reverse repurchase agreements (RRPs), as well as a potential decrease in bank deposits. A decline in these indicators would be a positive sign, suggesting that the liquidity drain has been offset.

Additionally, it’s important to remember that the cost of raising the debt ceiling is a reduction in government spending over the next two years, although the scale is not sufficient to significantly alter the economic outlook.

Contradiction 2:

In the stock market, almost every industry is witnessing the consolidation of major players, such as technology, banking, energy, retail, healthcare, and defense. As a result, the market-cap-weighted S&P index is rising while the equal-weighted S&P index is declining. This trend has been particularly pronounced since March. As the current rally is driven by AI as a core driver, the short-term benefits in terms of efficiency or performance may not be reflected across a wide range of industries. There is a potential for a bubble in the AI and technology sectors, especially considering that the P/E ratios of major tech companies are already more than double those of regular companies. The market is faced with the question of whether it is still willing to buy stocks with increasingly expensive valuations.

Contradiction 3:

Recently, there have been numerous hawkish comments from Fed governors, accompanied by consistently strong economic data. As a result, rate futures markets for 2023 have seen a continuous decline in rate expectations. Earlier this month, the predicted rate cut for 2023 was close to 100 basis points, but now the expectation has shifted to no cut (in line with the Fed’s March dot plot). This rapid shift occurred just last week, and its sustained impact can be considered to have not fully materialized yet.

Contradiction 4:

Despite the optimistic sentiment in the stock market, there was still a significant influx of funds into US money market funds last week (+$39.9 billion, the highest in five weeks). This indicates the strong attraction of fixed-income assets to capital, which is expected to remain stable in the coming months amidst fading expectations of interest rate cuts.

In summary, the majority of stocks have not participated in the upward trend, and the current trend is heavily influenced by the technology sector, particularly companies closely associated with AI and chips. The dominance of a few large-cap technology stocks may leave the market vulnerable, and any setbacks, such as disappointing earnings or changes in industry regulations, could have significant implications for the overall market.

There is also the possibility of more stocks following the upward trend of large technology companies, which would sustain the bull market, but this would require solid profit data to support it. While AI has indeed reduced investors’ reliance on interest rate changes, it can be expected that in the coming months, many companies will jump on the AI bandwagon conceptually. However, which industries can truly benefit from AI’s impact remains to be seen. Any stock price increases that cannot be supported by performance or increased dividends are fragile.

For example, according to Factset, only 110 companies in the S&P 500 mentioned artificial intelligence in their latest earnings conference calls.

Even innovation-focused funds such as ARKK have significantly underperformed NYFANG.

In the field of AI, it feels like many investors have not fully participated yet. While related companies may have high valuations, they are far from being in a bubble-like situation. We expect to witness the transformation of AI-related investment targets from being expensive to potentially reaching a bubble-like state, even evolving into meme-like trends. For example, the WSB community showed exceptional excitement for AI concepts last week.

This sentiment is likely to spread to the cryptocurrency market because both cryptocurrencies and AI are targets with significant adoption potential. However, concerns about liquidity and ongoing regulatory pressure may limit the upward momentum of the cryptocurrency market, unlike more mature industries.

The End.

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