RESEARCH

Shining a light

The Weekly Catch-up

Summary:

Flight to quality remains the name of the game, whether to the US dollar or in crypto, USDC stablecoin. A shocker of a CPI print in the US put expectations of a 100 bps hike on the table but also pulled forward the possibility of rate cuts in early 2023. Earnings are in the spotlight with the Street already bringing down estimates. In crypto, we note the positive steps by USDC to make its reserves more transparent. Transparency was not a characteristic of now bankrupt lender Celsius but we can now see the size of the loss thanks to poor risk management. 

Macro

This week’s US CPI was a shocker at +9.1%, the highest number since 1981, and accelerating to +1.3% mom, with a high diffusion of +70% (items with inflation over 4%). Core inflation, ex-food and energy, also remains sticky. The dollar index (DXY) spiked to almost 109 as a growing chance of a 100 bps rate increase is embedded in for July. That is a 14% move so far this year. Just a few weeks ago we were expecting 50 bps with a pause in September. 

Though commodities have weakened and gasoline prices at the pump are off their highs, there are other areas that still face upward pressure such as the lagging owners’ equivalent rent (+5.9%), so that inflation may stop accelerating but the headline can remain high for a few more months.

The market upped its rate hike expectations for now but just as importantly has also incorporated rate cuts to begin as early as February of next year, leading to a further inversion of the yield curve, a recessionary signal. The peak expected Fed funds rate has come down from 4% last month to 3.50-3.75% as markets expect inflation to fall back below 4% in 2023.

Headline inflation (YoY) gained steam in June and is broadening, a headache for policymakers

BATTERING DOWN THE HATCHES FOR A HURRICANE

Banking results are a finger on the pulse of the economy, setting the tone for the rest of what could prove to be a pivotal earnings season as participants tone down their previously optimistic outlook for 2022. A stronger dollar will also hamper earnings growth.

Earnings season did not start well with JP Morgan reporting a 28% decline in its second-quarter profit as it set aside $428 mn for loan loss provisioning in case the economy sours. This took a toll on profit, which fell by $8.65 bn, disappointing market expectations. Jamie Dimon, CEO of the bank said an economic hurricane is on the horizon but was uncertain about its severity. 

On the consumer side, spending on credit cards rose +21% yoy but tellingly card fees and bigger-ticket loans slumped, with mortgage originations down 45% and auto loan and lease origination down 44%.

Morgan Stanley reported a similar 29% yoy drop, posting a profit of $2.5 bn. Investment banking revenues fell by 55% as clients were quiet on the M&A front, though trading revenues were up 21% as like at JP Morgan, they profited from volatile markets.

EARNINGS WILL BE  KEY TO FURTHER P/E COMPRESSION

Sell-side research has been bringing down earnings forecasts for this quarter although there are still large discrepancies in their expectations, highlighting the uncertain outlook. Note Bank of America this week revising down their S&P target for year-end from 4,500 to 3,600. 

US banks are cutting overly optimistic S&P targets but there are still large variations and room for more cuts

According to Factset, for the second quarter, S&P 500 companies are expected to report earnings growth of +4.3% and revenue growth of +10.1%, the lowest growth since Q420 and down from an expected rate of 5.9% at the end of the first quarter. For Q3/Q4 2022 they are more optimistic, projecting earnings growth of 10.2%/9.4% and revenue growth of 9.5%/7.3%. 

The forward 12-month P/E ratio for the S&P 500 is 16.3. This P/E ratio is below the 5-year average (18.6) and below the 10-year average (17.0) but the clear risk is earnings estimates are too high.

The S&P is now below it’s 10 yr average 12 mth fwd P/E of 17x but earnings could fall 

Source: Bloomberg/Factset

Analysts have started to reduce earnings expectations, Q2 results will be pivotal

Source: Bloomberg

Labor costs and shortages are the most oft-cited negative factor in corporate earnings

Source: Factset

Crypto

STABLECOIN FLIPPENING?

Since the collapse of algorithmic stablecoin UST, user concerns around dollar-pegged Tether (USDT) resurfaced as evidenced by its market cap decline, with $7bn in redemptions in 48 hours post the Terra implosion, resulting in share gain by its peer, USDC, though USDT still dominates volumes. Tether’s current market cap stands at $66bn.

Flight to quality: With turmoil in crypto, investors have been moving out of the stablecoins or switching from Tether to USDC

Source: Bloomberg

WEN AUDITS?

Lack of transparency has been a common thread with the failure of centralized lending and borrowing platforms after the collapse of Terra and 3AC. USDT is known to have lower quality reserves than its competitor, USDC, though they have recently reduced their holdings of commercial paper and aim to eliminate them altogether. Both companies publish reports but full audits would immediately erase any doubts about their ability to fully redeem coins for USD.

On July 1st, Tether announced that its commercial paper holdings fell to $8.4bn from $20 bn previously, of which $5bn expire at the end of this month so they will be even less exposed. US Treasuries will increase as a percentage of reserves. The company publishes quarterly assurance reports so we have yet to see this in the documents. The company also announced that they had a BTC-denominated loan outstanding to now insolvent lending platform Celsius, which was 130% overcollateralized and say there was no loss to Tether from this.

Circle-backed USDC on the other hand, now publishes weekly attestations, though admittedly no audits yet. In a further bid to increase transparency, this week they published a breakdown of all the bonds they hold. 75% of their holdings are in Treasuries and 25% in cash.

Tether’s latest assurance report (not a full audit) from May 31st, showed over $20 bn in commercial paper, which it now says stands at $8.4bn

Source: Tether

In response to eroding confidence, decentralized lending platform, Aave, proposed its own decentralized USD-pegged collateral-backed stablecoin, GHO. Users will be able to borrow GHO against a crypto-collateral at their discretion without the need of a centralized intermediary. Although their collateral will be locked, borrowers will still be able to earn yield, which is algorithmically determined. When users repay their debt, the GHO is burned. 

Top defi lending protocol, Aave, proposed its own answer to a stablecoin, in the form of GHO, which could generate additional revenues

Source: Coingecko

DeFi

In terms of price performance, Defi assets diverged from BTC and ETH to end the week up 11%. Uniswap (+21%), Aave( +29%), Curve (+15%) and Compound (+25%) posted the best performance among the larger caps in DeFi.

Total Defi TVL, however, is down 2% for the week at $76.2 bn. Top lender Aave’s TVL was down 17%, while dydx derivatives exchange fell 10% and Compound saw a 5% increase. Bucking the trend, Tron protocol Just Lend’s TVL is up 12% and 94% so far this month and is number seven with a $3.2bn TVL. The DAO, the first lending app on Tron, sets interest rates based on algorithms.

Tron TVL picked up due to the popularity of Just Lend, which has 56% dominance onchain

Source: Defi Llama

CELSIUS FILES FOR BANKRUPTCY: ANOTHER ONE BITES THE DUST

As expected Celsius filed for bankruptcy this week, declaring a $1.2 bn hole in its balance sheet, which is a rosy scenario given the value of its CEL tokens is likely zero and other assets will sell at a haircut.

According to a court action filed by KeyFi, a firm hired to deploy DeFi strategies for Celsius, it failed to perform basic hedges on its ETH liabilities with depositors, which provoked huge losses when ETH shot up in 2021, and they had invested customer deposits in other coins. KeyFi also accuses Celsius of improper accounting that led to a $200 mn liability, improper security and pumping their own CEL token. Read full the report here

The truth is out: at least a $1.2 bn shortfall and a massive haircut for Celsius customers

It was also revealed that Celsius’ largest creditor, Pharos, with an $81 mn outstanding loan, may have links to one of Alameda’s co-founders revealing the wide reach of the platform and the spider web of connections.

UNISWAP PHISHING ATTACK

A gloomy economic outlook, tightening financial conditions and now hackers are giving more reasons to be bearish on crypto. A recent phishing attack on Uniswap has resulted in $4.7 million stolen from users who clicked the link to swap its currency for a "malicious token" called "UniswapLP" on the hacker's website. The hacker would then gain access to the wallet of the user and steal their crypto.

Despite the hack, the drop in price of 10% is consistent with the overall bearish market. Moreover, the hack wasn't a direct exploit of Uniswap’s protocol on Ethereum but rather a phishing attack in Web2 to which any industry can be a victim. 

Despite the phishing attack, Uniswap’s token fell in line with the market as traders recognized it was not a direct exploit

Until next week!

The Bequant Team

Martha Reyes

Emiliano Bruno

Callum Greaves

Artur Sakovich

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