AM Brew, May 11th 2022

Futures are quite healthy across the board as of 10:20 am London time - all US indices are up 1% to 1.5%. Other risk & non-risk assets are also participating: crude up 3.5% and gold is up 0.5%. More important is what is going on in Crypto: TerraUSD has dropped approximately 50% today and is trading well below $0.50. TerraUSD's 7 day waterfall is breath-taking; they should have named TerraUSD Niagara - flat until the falls:

Evidently TerraUSD is an algorithmic stable coin designed to hold parity with $1.00 through some type of trading arbitrage formula. A scalable trading arbitrage formula that guarantees stability in all scenarios? Wow, what could go wrong with that? Where have we heard that before? Applying modern-day portfolio insurance algorithms to crypto should not have succeeded in getting off the ground - that lesson was learned in 1987. Of course, people were told that they could lend their stable TerraUSD near 20% rates thus guaranteeing Buffett-like risk-free returns. What could go wrong? Janet Yellen is now calling for regulation of stable coins. This is potentially the most significant news of the month because regulation of stable coins would mean scrutiny for Tether. Remember that finance professor who essentially proved that they were minting free Tether (cost to mine = zero) and then using that to buy Bitcoin, thus creating the crypto revolution all by itself. A collapse in Tether would send the entire crypto world into a 5 year nuclear winter and the regulatory impact would be very difficult to overcome. The news over the last few days in TerraUSD is by far the most significant news since the Ukraine invasion. We still think supply constrained Bitcoin probably goes to $100,000 but now its an absolutely bi-modal distribution. Either crypto is going to recover to its normal higher-high or we are going to get massive regulation which won't be good. The government digging into Tether won't be good - they don't have $83 billion in cash plus crypto equivalent. Full $1 Tether backing was doubtful with BTC at $60,000 but now with BTC at 1/2 that level, do you really think Tether is adequately backed? We know Tether was backed by a combination of fiat & crypto, so this week's news is not good. A collapse in crypto would be further trouble for tech-type stocks. We can only hope that Yellen moves onto the next thing and they don't try to regulate stable-coins.

The other big news is the upcoming CPI report at 8:30 am EDT today. I haven't paid attention to one of these in decades. Normally we tell investors that these "big shocks" like inflation is 3% instead of 2% are nothing in the grand scheme of things, but today's report is a big deal because markets are on edge & almost any news can add to the fear.

Interestingly enough, Bloomberg is reporting that the cost of tail hedging, as measured by the CBOE Skew Index, is trading near its lows which implies that investors have de-levered & de-risked enough that there isn't huge demand for derivatives-style protection:

If you missed it, yesterday's subscriber chartbook is packed with a ton of interesting ways to look at the current environment. Markets this morning are starting to price in a much-needed Shanghai reopening based on "declining cases". Almost surely the Chinese government needs to reopen Shanghai, so this makes sense and is a bit of welcome news, even if it is just an expectation.