Trends We're Tracking: Uncertainty in China, FTX, and Treasury Market Liquidity

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Uncertainty in China

China’s unwavering commitment to its zero-covid policy has caused several issues for the country and driven civil and economic disruption.¹ Prolonged shutdowns across the country have impacted already stressed supply chains, leading large technology firms to shift manufacturing locations to other countries like Vietnam and India.² The shutdowns have also sparked civil unrest within the country after a fire in a locked down apartment building killed 10 people and Chinese citizens watch maskless attendees cheering their teams on at the World Cup.³ Some of the restrictions have been relaxed, but the uncertainty caused by the policy response will affect how U.S. companies do business in China moving forward.⁴

The demise of FTX

This month saw the rapid collapse of the major digital asset exchange FTX, with the company filing for bankruptcy only 9 days after initial reports of its insolvency. As concerns grew, customers triggered a “bank run” by withdrawing $5 billion worth of assets, before the exchange froze all account activity. As more information has come to light, reports show that FTX had around $16 billion of customer assets, but the books show a shortfall of around $8 billion, making many ask, “where did the money go?” While this question remains unanswered, the story suggests that Sam Bankman-Fried, FTX’s founder, transferred customer assets to backstop his crypto trading firm, Alameda Research, which lost the money.^5,6,7

The related fallout of such a sizable event has just started, with the recently announced bankruptcy of BlockFi.⁸ With such an unprecedented event, the industry faces many unknowns: How much further does the FTX contagion spread? How many other companies, hedge funds, and investor have been negatively impacted? How will the government respond? Without a doubt the industry has experienced a major setback, one which will likely take years to recover from. The one bright spot is that, despite the major failings of FTX, digital asset networks such and Bitcoin and Ethereum, continue to operate as normal allowing for ongoing development. It remains to been seen what lasting impact FTX’s spectacular demise will have on the digital asset space. 

Treasury market liquidity isn’t what it used to be

Treasury market liquidity, or rather the relative lack of it, is having another moment. The Bloomberg US Government Liquidity Index places current liquidity in the market on par with the extreme stress of March 2020, when yields spiked as market participants rushed to raise cash amid the onset of the COVID-19 pandemic. Growth in the amount of outstanding Treasury debt, which now stands at roughly $24 trillion in value, and changes in market structure since the Global Financial Crisis of 2007-2008, are often cited as contributing to an environment that spawns liquidity crunches. This manifested most recently in the 2019 repo market crisis and March 2020 crisis. The poor state of the market has been exacerbated by the Federal Reserve’s hawkish stance this year as it has raised its short-term policy rate aggressively and started to wind down its balance sheet in a process known as “quantitative tightening.” Regulators are mooting changes to alleviate the problem and the Treasury Department is considering a buyback scheme for illiquid off-the-run bonds. But for the time being, many participants view the gyrations of the world’s largest bond market not just as a reflection of risk, but as a potential source of it.^9,10,11

Worker’s discontent and railroad strikes threaten supply chains

A U.S. nationwide freight rail strike was in the works during the month of November and expected to start on December 9th, just in time for the busy holiday season. Realizing the crippling impact this could have on the economy, Congress has been taking measures to try and avert a major crisis. At the time of writing, the House and Senate passed legislation driving unions to adopt a contract which was negotiated between the Biden administration, rail companies, and labor leaders. However, a separate proposal to add seven days of paid sick leaves for workers was rejected in the Senate. While the threat of an immediate strike weeks before Christmas was avoided, rising worker discontent in transport and freight may still cause disruptions to the fragile supply chain.¹² 

In the U.S., roughly 40% of the nation’s freight moves by rail and there is no easy substitution if there is a temporary shutdown. This comes at a time when the average profit margin of railroad companies continues to climb and high inflation erodes wages. So, unless a constructive all-stakeholder negotiation culminates, businesses and investors should anticipate the potential for future disruptions to the supply chain. 

This seems to be a global issue as truck drivers in South Korea have plans to block all ports. A similar strike which happened in June costed close to $1.2 billion and industries like auto, petrochemical, and steel were hit. In the U.K., ‘The National Union of Rail, Maritime, and Transport Workers’ said that their workers will strike a few days in December and early January, potentially impacting hospitality, and retail sectors. In China, a worker’s protest against covid restrictions in an Apple manufacturing hub is expected to result in production shortfalls this year.^13,14 

Sources:
1. “China’s steampunk covid response,” The Economist, November 17, 2022, https://www.economist.com/china/2022/11/17/chinas-steampunk-covid-response 

2. Daisuke Wakabayashi and Tripp Mickle, “Tech Companies Slowly Shift Production Away From China,” The New York Times, September 1, 2022, https://www.nytimes.com/2022/09/01/business/tech-companies-china.html 

3. Emily Feng, “How a deadly fire in Xinjiang prompted protests unseen in China in three decades,” NPR.org, 11/26/22, https://www.npr.org/2022/11/26/1139273138/china-protests-covid-lockdown-urumqi-beijing

4. “China tweaks its zero-covid policy,” The Economist, November 17, 2022, https://www.economist.com/china/2022/11/17/china-tweaks-its-zero-covid-policy 

5. Matt Levine, “FTX’s Balance Sheet Was Bad,” Bloomberg, November 14, 2022, https://www.bloomberg.com/opinion/articles/2022-11-14/ftx-s-balance-sheet-was-bad

6. Ian Allison, “Divisions in Sam Bankman-Fried’s Crypto Empire Blur on His Trading Titan Alameda’s Balance Sheet,” Coindesk.com, November 2, 2022, https://www.coindesk.com/business/2022/11/02/divisions-in-sam-bankman-frieds-crypto-empire-blur-on-his-trading-titan-alamedas-balance-sheet/

7. “The spectacular fall of FTX and Sam Bankman Fried,” The Economist, November 9, 2022, https://www.economist.com/finance-and-economics/2022/11/09/the-spectacular-fall-of-ftx-and-sam-bankman-fried

8. Nikhilesh De, “BlockFi Files for Bankruptcy as FTX Contagion Spreads,” Coindesk.com, November 28, 2022, https://www.coindesk.com/policy/2022/11/28/ftx-fallout-continues-as-crypto-lender-blockfi-declares-bankruptcy/

9. Annette Vissing-Jørgensen, “The Treasury market in spring 2020 and the response of the Federal Reserve,” BIS Working Papers, October 19, 2021, https://www.bis.org/publ/work966.htm

10. Kate Duguid and Colby Smith, “Investors urge US Treasury to boost bond market liquidity with buyback scheme,” Financial Times, October 30, 2022, https://www.ft.com/content/3218c8b4-76bc-4690-9a17-1cfa52eeb0ac

11. Kate Duguid and Tommy Stubbington, “The cracks in the US Treasury bond market,” Financial Times, November 14, 2022, https://www.ft.com/content/632411eb-c3fa-4351-a3b6-b0e30bdc0ef7

12. Erik Wasson, “House Passes Bill to Avert US Rail Strike, Impose Contract,” Bloomberg, November 30, 2022, https://www.bloomberg.com/news/articles/2022-11-30/house-passes-bill-to-avert-us-rail-strike-impose-labor-contract

13. Josh Funk, “A rail strike looms and impact on US economy could be broad,” AP News, November 22, 2022, https://apnews.com/article/business-economy-strikes-climate-and-environment-government-politics-92ea7632a29f807ccc0e2658c50d731e

14. Thomas Black, “Railroads Get Off Track in Obsessing About Profit Margins,” Bloomberg, August 3, 2022, https://www.bloomberg.com/opinion/articles/2022-08-03/railroads-like-union-pacific-and-bsnf-get-off-track-in-focusing-on-margins