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America’s dangerous reliance on the Fed

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For bitcoin speculators, last year was a bonanza. The cryptocurrency started January 2020 at $7,194 and on Sunday surged above $34,000 — a more than 360 per cent annual return. 

Courtesy of the US Federal Reserve, asset buyers in general have had a stellar pandemic. Whether it was US Treasuries or junk bonds, equity portfolios or high-end property, the free money gusher has lifted all asset prices. Nor is the Fed inclined to stop the party. This year could offer a similar kind of boom to last.

Even if they do not trigger high inflation, the Fed’s extraordinary interventions will come with steep price tags. No doubt these would be far lower than the Fed not having acted at all — particularly in the short term. Had it foregone the more than $3tn expansion to its balance sheet since last March, the US economy would have gone into freefall. Corporate bankruptcies would have piled up and there could have been a 2008-style financial meltdown.

The response to critics is the same today as it was after the 2008 crisis: that the Fed is doing whatever it takes to prevent a depression. But the risk is that each new chapter tightens a doom loop in which the US sovereign must eventually reckon with the ever-widening class of risk it is underwriting. America’s national debt is already past 100 per cent of gross domestic product for the first time since the second world war. It nearly doubled after 2008 and is rising sharply again. As Japan has shown, high indebtedness need not trigger a crisis. Its national debt is well over 200 per cent cent of GDP. But as the issuer of the world’s reserve currency, the US must guard its role carefully.

The most visible threat, however, is to US political stability. The Fed’s quantitative easing boosts wealth inequality by increasing the net worth of those who own financial assets, chiefly of stocks and bonds. The top 10 per cent of Americans own 84 per cent of the country’s shares. The top 1 per cent own about half. The bottom half of Americans — the ones who have chiefly been on the frontline during the pandemic — say they own almost no stocks at all.

The further up the scale you go, the greater the gains. The S&P 500 showed a return of around 16.2 per cent in 2020. Its global luxury index yielded a remarkable 34 per cent. To be sure, many of the equity market’s gains have gone to big tech companies, such as Amazon and Netflix, which have benefited from the partial closure of the physical economy. But their gains have heavily outweighed losses in the worst hit sectors, such as cruise liners and oil drillers. All that money must find some place to go. At the start of last year, five-year Treasury bonds yielded 1.67 per cent. By the end, it had fallen to 0.37 per cent.

As my colleagues have reported, the Fed’s inescapable bias towards asset owners has combined with the financial sector’s preference for size to produce a very skewed recovery. This has benefited big companies, even junk-rated ones, at the expense of small businesses, including financially-sound ones. And it has boosted wealthy individuals over median households. After 2008, the economic recovery coexisted with a so-called “main street recession”. Today we call it a K-shaped recovery. The majority of people are suffering amid a Great Gatsby-style boom at the top.

Whatever we label it, the political reaction is unlikely to be positive. The coincidence is unfortunate for Democratic presidents. Just as Barack Obama inherited the Great Recession, Joe Biden is walking into the Great Pandemic. In Mr Obama’s case the backlash to his two-speed economy triggered a Tea Party populism that eventually brought his presidency to a halt. Not much of fiscal note happened after his initial $787bn stimulus in February 2009. That meant the Fed had to go on doing the work of keeping the economy afloat. In 2013, the Fed chair, Ben Bernanke, announced plans to reduce the scale of its bond-buying programme known as quantitative easing. He was quickly forced to reverse after the market went into a “taper tantrum”.

Mr Biden could find himself in a similar two-speed economy. Last month Congress passed a $900bn stimulus, which will tide over most unemployed Americans until March and send $600 cheques to individuals earning less than $75,000 a year. But his chances of passing a far larger “build back better” relief package after he takes office look slim. By contrast, Jay Powell, the Fed chair, has said the central bank’s support could be indefinite. The Fed will continue to buy $120bn of debt a month for the foreseeable future.

Here are the potential seeds of America’s next populist crisis. The Fed is pledging to do what it takes, while America’s elected officials seem unlikely to agree on fiscal policy. The right emphasis, as Mr Powell keeps reminding Congress, would be the other way round. Monetary policy is a blunt tool. Spending by contrast can be targeted at those who need it and help lift America’s growth potential.

Alas, the chances are that the Fed will remain “the only game in town”. This would be both a missed opportunity and pose a severe danger. The opportunity is for the US government to borrow long term funds at near zero rates and invest it in productive capacity. The danger of not doing that can be expressed in a simple equation: QE — F = P. Quantitative easing minus fiscal action equals populism.

edward.luce@ft.com



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European stocks stabilise ahead of US inflation data

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European equities stabilised on Wednesday after a US central banker soothed concerns about inflation and an eventual tightening of monetary policy that had driven global stock markets lower in the previous session.

The Stoxx 600 index gained 0.4 per cent and the UK’s FTSE 100 rose 0.6 per cent. Asian bourses mostly dropped, with Japan’s Nikkei 225 and South Korea’s Kospi 200 each losing more than 1.5 per cent for the second consecutive session.

The yield on the 10-year US Treasury bond, which has dropped in price this year as traders anticipated higher inflation that erodes the returns from the fixed interest securities, added 0.01 percentage points to 1.613 per cent.

Global markets had ended Tuesday in the red as concerns mounted that US inflation data released later on Wednesday could pressure the Federal Reserve to start reducing its $120bn of monthly bond purchases that have boosted asset prices throughout the Covid-19 pandemic.

Analysts expect headline consumer prices in the US to have risen 3.6 per cent in April over the same month last year, which would be the biggest increase since 2011. Core CPI is expected to advance 2.3 per cent. Data on Tuesday also showed Chinese factory gate prices rose at their strongest level in three years last month.

Late on Tuesday, however, Fed governor Lael Brainard stepped in to urge a “patient” approach that looks through price rises as economies emerge from lockdown restrictions.

The world’s most powerful central bank has regularly repeated that it will wait for several months or more of persistent inflation before withdrawing its monetary support programmes, which have been followed by most other major global rate setters since last March. Investors are increasingly speculating about when the Fed will step on the brake pedal.

“Markets are intensely focused on inflation because if it really does accelerate into this time near year, that will force central banks into removing accommodation,” said David Stubbs, global head of market strategy at JPMorgan Private Bank.

Stubbs added that investors should look more closely at the month-by-month inflation figure instead of the comparison with April last year, which was “distorted” by pandemic effects such as the price of international oil benchmark Brent crude falling briefly below zero. Brent on Wednesday gained 0.5 per cent to $69.06 a barrel.

“If you get two or three back-to-back inflation reports that are very high and above expectations” that would show “we are later into the economic recovery cycle,” said Emiel van den Heiligenberg, head of asset allocation at Legal & General Investment Management.

He added that the pandemic had sped up deflationary forces that would moderate cost pressures over time, such as the growth of online shopping that economists believe constrains retailers’ abilities to raise prices. Widespread working from home would also encourage more parents and carers into full-time work, he said, “increasing the labour supply” and keeping a lid on wage growth.

In currency markets on Wednesday, sterling was flat against the dollar, purchasing $1.141. The euro was also steady at $1.214. The dollar index, which measures the greenback against a group of trading partners’ currencies, dipped 0.1 per cent to stay around its lowest since late February.



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Potash/grains: prices out of sync with fundamentals

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The rising tide of commodity prices is lifting the ricketiest of boats. High prices for fertiliser mean that heavily indebted potash producer K+S was able to report an unusually strong first quarter on Tuesday. Some €60m has been added to the German group’s full year ebitda expectations to reach €600m. Its share price has gone back above pre-pandemic levels.

Demand for agricultural commodities has pushed prices for corn and soyabeans from decade lows to near decade highs in less than a year. Chinese grain consumption is at a record as the country rebuilds its pork herd. Meanwhile, the slowest Brazilian soyabean harvest in a decade, according to S&P Global, has led to supply disruptions. Fertiliser prices have risen sharply as a result.

But commodity traders have positioned themselves for the rally to continue for some time to come. Record speculative positions in agricultural commodities appear out of sync even with a bullish supply and demand outlook. US commodity traders have not held so much corn since at least 1994. There are $48bn worth of net speculative long positions in agricultural commodities, according to Saxo Bank.

Agricultural suppliers may continue to benefit in the short term but fundamentals for fertiliser producers suggest high product prices cannot last long. The debt overhang at K+S, almost eight times forward ebitda, has swelled in recent years after hefty capacity additions in 2017. Meanwhile, utilisation rates for potash producers are expected to fall towards 75 per cent over the next five years as new supply arrives, partly from Russia. 

Yet K+S’s debt swollen enterprise value is still nine times the most bullish analyst’s ebitda estimate, and 12 times consensus, this year. Both are a substantial premium to its North American rivals Mosaic and Nutrien, and OCI of the Netherlands, even after their own share prices have rallied.

Any further price rises in agricultural commodities will depend on the success of harvests being planted in the US and Europe. Beyond restocking there is little that supports sustained demand.

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Amazon sets records in $18.5bn bond issue

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Amazon set a record in the corporate bond market on Monday, getting closer to the level of interest paid by the US government than any US company has previously managed in a fundraising. 

The ecommerce group raised $18.5bn of debt across bonds of eight different maturities, ranging from two to 40 years, according to people familiar with the deal. On its $1bn two-year bond, it paid just 0.1 percentage points more than the yield on equivalent US Treasury debt, a record according to data from Refinitiv.

The additional yield above Treasuries paid by companies, or spread, is an indication of investors’ perception of the risk of lending to a company versus the supposedly risk-free rate on US government debt.

Amazon, one of the pandemic’s runaway winners, last week posted its second consecutive quarter of $100bn-plus revenue and said its net income tripled in the first quarter from the same period a year ago, to $8.1bn.

The company had $33.8bn in cash and cash equivalents on hand at the end of March, according to a recent filing, a high for the period.

“They don’t need the cash but money is cheap,” said Monica Erickson, head of the investment-grade corporate team at DoubleLine Capital in Los Angeles.

Spreads have fallen dramatically since the Federal Reserve stepped in to shore up the corporate bond market in the face of a severe sell-off caused by the pandemic, and now average levels below those from before coronavirus struck.

That means it is a very attractive time for companies to borrow cash from investors, even if they do not have an urgent need to.

Amazon also set a record for the lowest spread on a 20-year corporate bond, 0.7 percentage points, breaking through Alphabet’s borrowing cost record from last year, according to Refinitiv data. It also matched the 0.2 percentage point spread first paid by Apple for a three-year bond in 2013 and fell just shy of the 0.47 percentage points paid by Procter & Gamble for a 10-year bond last year.

Investor orders for Amazon’s fundraising fell just short of $50bn, according to the people, in a sign of the rampant demand from investors for US corporate debt, even as rising interest rates have eroded the value of higher-quality fixed-rate bonds.

Highly rated US corporate bonds still offer interest rates above much of the rest of the world.

Amazon’s two-year bond also carried a sustainability label that has become increasingly attractive to investors. The company said the money would be used to fund projects in five areas, including renewable energy, clean transport and sustainable housing. 

It listed a number of other potential uses for the rest of the debt including buying back stock, acquisitions and capital expenditure. 

In a recent investor call, Brian Olsavsky, chief financial officer, said the company would be “investing heavily” in the “middle mile” of delivery, which includes air cargo and road haulage, on top of expanding its “last mile” network of vans and home delivery drivers.



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