Duet Protocol Global Market Chat Recap — 20230515

Duet Protocol
10 min readMay 15, 2023

Gm gm Dueters,

Nice to see you again in our community hours. I hope you enjoyed our weekly global market chat in which we hope to share market news and insights and help everyone get ready for the coming trading week!

We also hope that with the knowledge you get from our sharing, you can perform outstanding trading skills on our RWA (Real World Asset) perpetual future trading platform, Duet Pro, and gain significant fortune utilizing the high leverage up to 100x. Or, if you prefer less risky investment, you can simply gain passive income by staking your USDC in our LP, which offers its contributors 80% transaction fee return and even more (stay tuned for updates!).

After listening to the Market Chat for 15 min, you are eligible to claim the Galxe series OAT: https://galxe.com/DuetProtocol/campaign/GCpEZUEHYJ.

If you missed the Market Chat, here’s the recording: https://twitter.com/duetprotocol/status/1658086301743329280.

If you prefer text, please read on. Here’s a recap we prepared for you.

Duet Protocol Global Market Chat Recap — 20230515

It’s a new week, and the US market is about to open. Let’s first take a look back at the important developments from last week, so that investors can make predictions for the market this week. In the second half, we’ll discuss the potential impact of the debt ceiling negotiations.

Last week, the 3 US major stock indices showed mixed performance. The Dow Jones Industrial Average (DJIA) dropped over 1% for the week, while the S&P 500 declined by 0.29%. On the other hand, the Nasdaq Composite saw a slight increase of 0.40%. After the release of inflation data on Wednesday, market volatility intensified.

In terms of sectors, the communication sector performed strongly, with an increase of over 4%. Non-essential goods also saw a rise of 0.61%. However, other sectors experienced declines, with the energy sector falling over 2% and the materials sector dropping nearly 2%.

Regarding interest rates, the yield curve for government bonds flattened slightly. The yield on 10-year Treasury bonds increased by 0.84% to reach 3.47%. The yield on 3-month Treasury bonds declined slightly by 0.05% to 5.22%, maintaining its highest level since the dot-com bubble in 2000.

Oil prices experienced a decline of 1.77%, with USOIL closing the week at $70.03 per barrel. The US dollar strengthened by 0.63%, with the DXY index reaching 102.71.

Gold prices initially surged but then retreated, falling from a high of $2,045 to around $2,010 for the week, resulting in a 0.3% decline. Cryptocurrencies followed a similar trend, briefly surging after the inflation data but quickly declining. Bitcoin hit a new low since March 17th, while Ethereum reached a new low since April 2nd. Overall, cryptocurrencies experienced a decline of around 2.5% for the week.

In terms of macroeconomic news from last week, the Consumer Price Index (CPI) data generally met expectations, with a nominal inflation rate of 4.9% and a core inflation rate of 5.5%. The Producer Price Index (PPI) had a year-on-year increase of 2.3%, lower than expected but close to the Federal Reserve’s target. The University of Michigan Consumer Sentiment Index showed that long-term inflation expectations among Americans reached a new 12-year high at 3.2%.

Last week, several Federal Reserve officials expressed hawkish views, emphasizing that inflation remains elevated and that further rate hikes “might be appropriate.” For example:

Federal Reserve Governor Jefferson stated that the progress in core inflation is “disappointing” and predicted a slowdown in consumer spending growth by the end of the year. The comprehensive impact of rapid rate hikes may soon become evident.

St. Louis Fed President Bullard indicated that the prospects for combating inflation are favorable but not guaranteed. Currently, the policy is at the lower end of a sufficiently restrictive level.

Federal Reserve Governor Bowman believes that the inflation rate remains too high. If inflation remains elevated and the labor market remains tight, further rate hikes “might be appropriate.”

On the other hand, there are some dovish officials, such as Chicago Fed President Goolsbee, who believe that while the inflation rate is still high, it is at least declining. The United States has no choice but to raise the debt ceiling.

These comments indicate a divergence from Chairman Powell’s hints at pausing rate hikes, which were quite explicit during the previous press conference. In response to this, Nick WSJ reporter aka the “Fed whisperer”, commented that there is a growing internal divergence within the Federal Reserve. While most officials believe that the current level is sufficiently tight, there are still many who think it should be higher. Recently, some officials, like Chicago Fed President Gulspie, have become more concerned about future credit market risks, while officials like Bowman and Bullard remain concerned about the current inability to lower inflation.

Since voting consensus is also a market signal, divergent voting patterns undermine the credibility of Chairman Powell’s statements, affecting the transmission of information from the Federal Reserve and increasing policy uncertainty for the future. Powell needs to bring the committee members to a consensus.

On the other hand, despite inflation numbers last week coming in better than expected, the Michigan Consumer Sentiment data showed an increase in long-term inflation expectations. In the data released on Friday, consumers’ inflation expectations for the next year stood at 4.5%, slightly lower than the previous month’s 4.6% but higher than Wall Street’s estimated 4.4%. Long-term inflation expectations reached their highest point since 2011, at 3.2%, surpassing the previous range of below 3%. The rise in inflation expectations is a major concern for the Federal Reserve as it can make high inflation more persistent.

Currently, the Federal Reserve can still claim that controlling inflation will take time and needs to proceed at a steady pace, largely because consumer expectations of inflation remain low. Consumers believe that future inflation will retreat to 2%. However, as time goes on, consumer confidence in this expectation may waver, making it more difficult for the Federal Reserve to control inflation.

It’s worth mentioning why an increase in inflation expectations can fuel inflation. Simply put, if all participants in the economy anticipate persistent high inflation, they will adjust their behavior accordingly, ultimately leading to the realization of those expectations. For instance, if the public expects high inflation to persist, they may start consuming earlier due to concerns about higher future prices. This increased demand can lead to price hikes, creating a cycle. Additionally, individuals may demand higher wages from their employers to maintain their daily expenses, resulting in wage increases. If business owners also anticipate sustained high inflation and rising costs, they may continue to raise prices to offset those costs.

Therefore, when this data was released on Friday, it triggered a decline in both the US stock market and cryptocurrencies.

In fact, signals from hawkish Federal Reserve officials, such as Bowman, are essentially a reminder to the market not to assume that the Fed will pause at the next meeting. If the next non-farm payrolls report remains robust, with wages rising beyond expectations, it is not ruled out that the Federal Reserve may continue with rate hikes.

However, in my view, whether the next meeting results in a pause or further rate hikes is not important anymore. The market has already priced in a shift in the Federal Reserve’s policy, and even an additional rate hike would not change this trend. Looking ahead, what matters more is the reason behind the Fed’s shift and the conditions that led to it. There are 2 potential scenarios: 1) Inflation is no longer a threat, or 2) there is a significant financial stability issue. If we wait for scenario 1 to materialize, the main risk is that it may take too long as inflation has already exhibited stickiness. Scenario 2, on the other hand, could lead to a sharp market decline in the short to medium term, although the market is expected to rebound in the long run with an accommodative monetary policy will come anyway·.

In the upcoming week, US Treasury traders will be highly alert to any signs from Washington regarding the possibility of a market-disrupting default or a last-minute debt compromise.

President Biden has indicated that discussions on the US debt ceiling are progressing, and parties are exploring possible alternatives. The debt ceiling meeting is scheduled for this Tuesday, and there is optimism surrounding the negotiations.

However, it is crucial to note that if Biden and congressional leaders fail to make significant progress on Tuesday, the crisis may dangerously approach the “X-day.” Biden’s plans to attend the G7 leaders’ summit in Japan on Wednesday make it challenging for negotiations that are already mired in a quagmire to achieve significant breakthroughs.

As the window for raising the debt ceiling rapidly narrows, Federal Reserve officials’ economic data and comments will unusually take a backseat. The Treasury Department warned on Friday that it only has $88 billion in extraordinary measures as of May 10th.

Therefore, the negotiations between President Joe Biden and House Speaker Kevin McCarthy in the next few days will hold immense significance for the global market, even with US retail sales data and appearances by Federal Reserve Chair Jerome Powell on the agenda. Additionally, at least eight Federal Reserve officials are scheduled to deliver speeches.

However, it is important to note that if Biden and congressional leaders fail to make significant breakthroughs on Tuesday, the crisis may dangerously approach the “X-day.” Biden’s plans to attend the G7 leaders’ summit in Japan on Wednesday make it difficult for later negotiations to achieve major progress before June.

While the pricing in the market does not indicate significant pessimism, the increased demand for protection against more extreme tail events is evident. For example, the one-year credit default swap (CDS) for the US treasury has expanded to 172 basis points, the highest level in history. However, despite this, the absolute pricing levels in the US Treasury itself and CDS markets are not expensive, which suggests that a comprehensive crisis is still a low-probability event. Additionally, the VIX index has remained at low levels since 2021, hovering around 17.

In the options market, there is a heightened demand for hedging against volatility breakouts, reaching the highest level in five years. This indicator is measured by the open interest in VIX options, which is at its highest level since early 2018.

However, seasoned experts warn that this calm may be the calm before the storm, similar to what was observed in 2011 when few people paid attention to the financing deadlock until the brink of default.

If the negotiations continue to deteriorate, the situation could rapidly change. A default could trigger significant volatility worldwide, and the prospects of a sharp economic downturn and a reassessment of the Federal Reserve’s monetary policy could lead to abnormal buying of US Treasuries as a safe haven.

The counterintuitive phenomenon is that recently, bond market yields have generally remained low, with minimal pressure on risk assets. However, it is important to note that the situation may reverse after the debt ceiling is raised.

As the debt ceiling date approaches, it is not surprising to see a decline in bond yields since there are fewer new bonds being issued, resulting in scarcity and price increases. However, short-term bonds exhibit greater uncertainty and their yields tend to rise, as can be observed by the noticeable divergence in the trends between 1–3 month duration bonds and longer-term bonds.

After the debt ceiling is raised, the government will undoubtedly replenish its treasury funds and issue more bonds, causing bond yields to rise and impacting the market. In recent years, the Treasury Department has aimed to maintain a balance of at least $500 billion in its accounts. If the balance is essentially zero on the X-date, it means an additional issuance of $500 billion in US Treasury bonds in the short term. By the second half of the year, it could reach a level of $1.2 trillion. So, while many people believe that the recent decline in bond yields is due to lower inflation, in the medium term, yields may not necessarily decrease along with inflation and could instead rebound.

Furthermore, the current elevated levels of the Federal Reserve’s reverse repurchase agreement (RRP) rates, aligned with the US benchmark interest rate, are as high as 5.11%, with a scale of around $2.25 trillion. These rates are transmitted to the money market through money market funds. As a result, more and more depositors are transferring their cash to money market funds, which in turn invest the funds with the Federal Reserve. This creates a de facto liquidity drain effect on the financial system.

In addition to the current state of the US banking system and the wavering confidence, the further depletion of bank cash reserves may amplify risks in the economic system. While it may not necessarily lead to a cascading crisis event, it will certainly have a negative impact on the lending market. In fact, tightening conditions have already occurred. According to Goldman Sachs’ statistics, after the Silicon Valley Bank’s collapse, the loan-to-value (LTV) ratio between new loans and collateral value dropped to 51%, below the average level of 60% seen in the later stages of the COVID period. This means that if the collateral value is $1 million, the loan amount would be $510,000.

The end.

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