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Bank of England should switch strategy on QE



The writer is head of macro research at BNP Paribas Asset Management

The Bank of England has invested hundreds of billions of pounds in the bond market over more than a decade since the financial crisis. The time has surely come to reflect on how this programme works and whether there is a better way.

The BoE clearly needed to respond when the UK economy went back into lockdown. The markets expected an expansion of the central bank’s asset purchase programme, known as quantitative easing, and they were not disappointed.

What is surprising though is the way that the BoE thinks that QE influences the economy and the way it conducts those asset purchases.

There are two schools of thought about how QE affects the economy and two schools of thought about how long the effect lasts.

Starting with how, most investors believe in an intuitive demand-versus-supply explanation of QE. In the process of buying bonds, central banks bid up the price, driving down bond yields.

This argument is controversial in academia, where it is sometimes argued that demand and supply do not determine yields — certainly not in the long run. Instead, it is argued that it is the signal implicit in a central bank’s decision to purchase assets that influences the bond market. That signal could be about the central bank’s assessment of the state of the economy or how it plans to respond to events in the future.

Turning to how long, the “stock theory” that is favoured by many economists argues that purchases which took place long ago under previous governors Mervyn King and Mark Carney are still influencing rates today. In contrast, the “flow theory” that is favoured by some investors argues that the size of the bond portfolio that the BoE has accumulated over the past decade is not relevant to current bond yields: only transactions move markets.

The BoE’s Monetary Policy Committee appears to believe simultaneously in the signalling explanation and the stock theory in setting a target for purchases. That is a puzzle on many levels. First, the committee must believe that the message that Lord King encrypted within the decisions to purchases bonds a decade ago is somehow still having an impact on yields. 

Second, QE is an extraordinarily expensive and opaque way to send a signal. The BoE assumes that the market can correctly decode the message that is embedded within the decision to buy billions of bonds. If the committee has a signal to send then it should carefully calibrate the message and just say it. 

But perhaps the biggest puzzle of all is why the BoE persists with its current approach given no one is quite sure how a given quantity of bond purchases influences bond yields — which is what the central bank ultimately cares about.

Fortunately, there is a simple solution known as yield curve control. The MPC should vote on the target level of bond yields that it believes is consistent with price stability and then adjust the quantity of bond purchases as necessary to deliver that target.

This is not a revolutionary idea. The Bank of Japan has been implementing yield curve control for years. The European Central Bank appears to have informally — but perhaps only temporarily — adopted yield curve control during the Covid-19 crisis.

At the start of the bond-buying experiment, it was reasonable to argue that QE could stimulate spending by reducing short to medium-term interest rates. But bond yields at those horizons have now been crushed down close to zero. And with little hope that spending is particularly sensitive to the limited further falls in long-term yields still possible, it is getting increasingly difficult to argue that additional QE can provide extra stimulus. 

The reality is that it is now fiscal policy that is doing the heavy lifting to support the economy through the pandemic. Governments have been obliged to borrow huge sums.

QE can still play an important supporting role in these circumstances by absorbing the increase in bond issuance. Rather than pushing yields down to stimulate spending, the objective of QE is now to maximise the positive impact of government spending by preventing yields from rising in response.

Yield curve control is clearly preferable to conventional QE in the current circumstances. Investors may even stabilise interest rates around the yield target without the BoE actually having to intervene.

The alternative is the central bank feeling obliged to increase QE whenever the government signals more issuance is coming. That can feed the unfortunate narrative that the government is now calling the shots on bond purchases.

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Earnings beats: lukewarm reaction shows prices are stretched




Investors are picking over first-quarter results for signs of economic recovery and proof that record market highs can continue. Stock markets have only been this richly valued twice before — in 1929 and 2000. Bulls hope strong corporate earnings and rising inflation can pull prices higher still. But pricing for perfection means even good results can be met with indifference.

L’Oreal illustrated this trend on Friday. The French cosmetics group stated that sales in the first quarter of the year rose 10.2 per cent. This was a better performance than expected. Yet the announcement sent shares down by around 2 per cent. Weak cosmetics sales were seen as a veiled warning that consumers emerging from lockdowns might not spend as freely as hoped.

Online white goods retailer AO World, a big winner from pandemic home upgrades, also offered a positive update this week. In the quarter that marked the end of its financial year, sales were £30m ahead of forecasts. But even upbeat commentary from boss John Roberts could not stop shares slipping 3 per cent.

Banks are not immune. Their stocks have outperformed the market by 7 per cent in Europe and 12 per cent in the US this year. But stellar Wall Street results were not enough to satisfy investors this week.

JPMorgan Chase, the biggest US bank, smashed expectations for the first quarter. Even adjusting for the release of large loan loss reserves, earnings per share beat expectations by 12 per cent because of higher investment banking revenues. Bank of America earnings also rose thanks to the release of loan loss reserves. Yet shares in both banks ended the week down. Goldman Sachs had to pull out its best quarterly performance since 2006 to hold investor interest.

On multiple metrics, stock valuations look steep. On price to book, banks are now back to the pre-crisis levels recorded at the start of 2020. Living up to the expectation implicit in such valuations is becoming increasingly hard.

Lex recommends the FT’s Due Diligence newsletter, a curated briefing on the world of mergers and acquisitions. Click here to sign up.

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Barclays criticised for underwriting US private prison deal




Barclays has attracted criticism for underwriting a bond offering by the US company CoreCivic to fund the building of two new private prisons, in a new dispute over Wall Street’s relationship with the controversial sector.

The UK-based bank said two years ago that it would stop financing private prison companies, but the commitment did not extend to helping them obtain financing from public and private markets.

About 30 activists and investors, among them managers at AllianceBernstein and Pax World Funds, have signed a letter opposing the $840m fundraising for two new prisons in Alabama, which was due to be priced on Thursday.

The signatories said the bond sale brings financial and reputational risk to those involved and urged “banks and investors to refuse to purchase securities . . . whose purpose is to perpetuate mass incarceration”.

Activists and investors who pay attention to environmental, social and governance issues have sought to cut off companies that profit from a US criminal justice system that disproportionately incarcerates people of colour. As well as raising ethical issues, many also say such financing may be a bad investment because legislators are increasingly calling for an end to the use of private players in the prison system.

While Barclays is not lending to CoreCivic, activists and investors attacked its decision to underwrite the deal, which is split between private placements and public issuance of taxable municipal bonds. The arrangement is “in direct conflict with statements made two years ago” when the bank announced it would no longer finance private prison operators, according to the letter.

Barclays said its commitment to not finance private prisons “remains in place”, adding it had worked alongside representatives from the state of Alabama to finance prisons “that will be leased and operated by the Alabama Department of Corrections for the entire term of the financing”.

CoreCivic said the Alabama facilities will be “managed and operated by the state — not CoreCivic. These are not private prisons. Frankly, we believe it is reckless and irresponsible that activists who claim to represent the interests of incarcerated people are in effect advocating for outdated facilities, less rehabilitation space, and potentially dangerous conditions for correctional staff and inmates alike.”

Barclays’ 2019 commitment to limit its work with private prison companies came as other banks, including Wells Fargo, JPMorgan Chase and Bank of America, also said they would stop financing the sector.

Critics said they were not sure why Barclays is differentiating between lending and underwriting.

“You’ve already taken the stance, the right stance, that private prisons and profiting from a legacy of slavery is bad,” said Renee Morgan, a social justice strategist with asset manager Adasina Social Capital, one of the signatories of the letter. “But then you’re finding this odd loophole in which to give a platform to a company to continue to do business.”

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Hedge funds post best start to year since before financial crisis




Hedge funds have navigated the GameStop short squeeze and the collapse of family office Archegos Capital to post their best first quarter of performance since before the global financial crisis.

Funds generated returns of just under 1 per cent last month to take gains in the first three months of the year to 4.8 per cent, the best first quarter since 2006, according to data group Eurekahedge. Recent data from HFR, meanwhile, show funds made 6.1 per cent in the first three months of the year, the strongest first-quarter gain since 2000.

Hedge fund managers, who often bet on rising and falling prices of individual securities rather than following broader indices, have profited this year from a rebound in the cheap, beaten-down so-called “value” stocks and areas of the credit market that many of them favour. Some have also been able to profit from bouts of volatility, such as the surge in GameStop shares, which turbocharged some of their holdings and provided opportunities to bet against overpriced stocks.

“We’re going into a market environment that is going to be more fertile for most active trading strategies, whereas for most of the past decade buying and holding the index was the best thing to do,” said Aaron Smith, founder of hedge fund Pecora Capital, whose Liquid Equity Alpha strategy has gained around 10.8 per cent this year.

The gains are a marked contrast to the first three months of 2020, when funds slumped by around 11.6 per cent as the onset of the pandemic sent equity and other risky markets tumbling. However, funds later recovered strongly to post their best year of returns since 2009.

This year, managers have been helped by a tailwind in stocks and, despite high-profile losses at Melvin Capital and family office Archegos Capital, have largely survived short bursts of market volatility.

It’s a “good market for active management”, said Pictet Wealth Management chief investment officer César Perez Ruiz, pointing to a fall in correlations between stocks. When stocks move in tandem, it makes it more difficult for money managers to pick winners and losers.

Among some of the biggest winners is technology specialist Lee Ainslie’s Maverick Capital, which late last year switched into value stocks. Maverick has also profited from a longstanding holding in SoftBank-backed ecommerce firm Coupang, which floated last month, and a timely position in GameStop. It has gained around 36 per cent. New York-based Senvest, which began buying GameStop shares in September, has gained 67 per cent.

Also profiting is Crispin Odey’s Odey European fund, which rose nearly 60 per cent, having lost around 30 per cent last year, according to numbers sent to investors.

Odey’s James Hanbury has gained 7.3 per cent in his LF Brook Absolute Return fund, helped by positions in stocks such as pub group JD Wetherspoon and Wagamama owner The Restaurant Group. Such stocks have been helped by the UK’s progress on the rollout of the coronavirus vaccine, which has raised hopes of an economic rebound.

“We continue to believe that growth and inflation will come through higher than expectations,” wrote Hanbury, whose fund is betting on value and cyclical stocks, in a letter to investors seen by the Financial Times.

Additional reporting by Katie Martin

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