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US banks signal post-Covid optimism

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US banks signal post-Covid optimism

JPMorgan Chase, Citigroup and Wells Fargo have released more than $5bn of pandemic-era loan loss reserves in a sign of optimism for the economic outlook even as the US reels from the latest wave of Covid-19.

The move helped three of America’s biggest banks end the year on a high and reflects the lenders’ confidence that their clients will make good on debts despite the fallout from the pandemic.

“It’s not like we’re bragging, we’re not,” said Jamie Dimon, chief executive of JPMorgan, who added that the decision to release the reserves was driven in part by “positive vaccine and stimulus developments”.

But he also highlighted the risks to the world economy posed by coronavirus, noting that “our credit reserves of over $30bn continue to reflect significant near-term economic uncertainty”.

As US consumer sentiment fell and investors studied details of president-elect Joe Biden’s proposed $1.9tn additional stimulus, oil prices and Wall Street stocks dropped, including for banks, in a gloomy end to the week after disappointing US retail sales data.

Markets

Column chart of weekly flows into US municipal bond funds ($bn) showing investors ploughing into municipal debt after Democratic party’s victories

Investors have piled into US municipal bonds since Democrats clinched control of the Senate last week, as money managers positioned themselves for billions of dollars of aid to cash-strapped local governments. EPFR estimated $2.5bn had been placed into funds that invest in municipal debt, the largest inflow in at least a decade.

The pandemic has accelerated the trend among investors towards using alternatives to national accounts data in measuring macroeconomic performance, writes James Sweeney, chief economist at Credit Suisse. Nominal gross domestic product does not cover at-home production and free goods that comprise internet services, and is biased by inflation.

Private debt investors face a shakeout, fund managers have warned, after a decade-long boom propelled the sector’s assets to about $900bn. They warn that less stringent lending standards before the pandemic will mean a reckoning in the next couple of years, notably in retailing, leisure and hospitality that have been hit hard by pandemic restrictions.

Business

Line chart showing global bookings for all travel periods as a year-on-year % change, seven-day moving average

While leisure travel may bounce back once borders reopen, business travel faces a severe crisis and may not recover — raising concerns for hotels and airlines, which depend on it for up to 75 per cent of their revenue. The uptick in virtual gatherings, a greater focus on sustainability and post-pandemic cost-cutting at financially straightened companies risk long-term consequences.

Sales of low and no-alcohol drinks have held up during the pandemic even as global alcohol sales dropped almost 10 per cent as bar and restaurant closures cut social drinking. Demand remains modest but quality is improving. “Heineken 0.0 tastes like a beer, looks and smells like a beer,” said Edward Mundy, analyst at Jefferies.

Hundreds of thousands of UK businesses have won the right to claim on insurance for Covid-19 linked losses after the country’s top court ruled that many policies should pay out because of coronavirus and the government’s lockdown measures. About 700 types of insurance policies issued by 60 different insurers could be affected by the ruling from the Supreme Court.

Global economy

The UK economy risks entering a double-dip recession after shrinking for the first time in six months in November. The latest contraction was less severe than expected and much milder than in the spring. UK output fell 2.6 per cent compared with October, the first contraction since April’s lockdown, data from the Office for National Statistics showed.

Bar chart of general government gross debt as % of GDP (forecast for 2021) showing Latin America has the developing world’s highest debt levels

Latin America is the world’s worst-hit region by the coronavirus pandemic and its economy faces a slow and painful recovery, with a growing risk that worsening poverty and inequality will trigger political upheaval, economists have warned. Challenges for 2021 include the continuing spread of the virus, constraints on the amount of fiscal stimulus the region can afford and lack of political support for structural reforms to boost growth.

China’s trade surplus hit its highest ever monthly level in December, driven by higher demand for medical products and lockdown-related goods at a time when global trade has come under intense pressure. Exports rose above expectations at 18.1 per cent in dollar terms, while imports increased 6.5 per cent, pushing the trade surplus to a record $78bn.

Have your say

In response to Health and tech groups aim to create digital Covid ‘vaccination passport’, FT reader Euthydemus writes:

This digital passport infrastructure sets a dangerous precedent, which undoubtedly will be abused for other purposes in the future

The essentials

After the initial shock of the pandemic, those on the glide path to retirement are more mindful about their financial health, prompting many to seek professional financial advice. Money aside, planners are encouraging people in their fifties and sixties to do a better job of mapping out retirement goals by considering what they missed the most in the pandemic and what it made them reassess.

Final thought

Stephen Foster has advised on the books on show in films ranging from Disney to Bond
Stephen Foster has advised on the books on show in films ranging from Disney to Bond © Stephen Foster/Evening Standard/eyevine

The man who curates shelves in films has advice for Zoom users who want to improve the look of their on-screen libraries. “The key is authenticity,” says Stephen Foster, who has advised on books on show in movies from Disney to Bond. “If I have a bugbear, it’s the people who are trying too hard — turning the book so the front board is out.” The worst offenders? Politicians.

We would really like to hear from you. Please send your reactions or suggestions to covid@ft.com. Thanks



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Fed needs to ignore ‘taper tantrums’ and let longer rates rise

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The writer is chief executive officer and chief investment officer of Richard Bernstein Advisors 

The Ferber Method, a sleep training technique, teaches babies to self-soothe and fall asleep on their own. It’s as much a training technique for new parents to ignore their baby’s crying as it is for the child to learn to cope by themself. 

The US Federal Reserve should consider Ferberising bond investors and ignore future “taper tantrums” like the market disruption that occurred when the central bank signalled tighter monetary policy in 2013. The long-term health and competitiveness of the US economy may depend on bond investors’ self-soothing ability to cope with reality.

The slope of the yield curve is a simple model of the profitability of lending. Banks pay short-term rates on deposits and other sources of funds and receive longer-term rates by issuing mortgages, corporate loans, and other lending agreements.

A steeper curve, therefore, is a simple measure of better bank profit margins, and has in past cycles spurred greater willingness to lend. Historically, the Fed’s Survey of Senior Bank Lending Officers shows banks have been more willing to make loans to the real economy when the yield curve has been steeper.

A chart showing how banks have been more willing to lend with a steep yield curve. As the slope on the US treasuries  10-year-less-2-year yield curve has steepened, so the net percentage of banks reporting tighter lending standards has fallen

With that simple model of bank profits in mind, textbooks highlight the Fed’s control of short-term interest rates as a tool to control lending. The Fed reduces banks’ cost of funding and stimulates lending when it lowers interest rates. But it increases funding rates and curtails lending when it raises short-term rates. Coupling lower short-term rates with a steeper yield curve can be a powerful fillip to bank lending. 

However, policies in this cycle have been unique. As US short-term interest rates are near zero, the Fed has attempted to further stimulate the economy by buying longer-dated bonds and lowering long-term interest rates. Those actions have indeed lowered long-term borrowing costs in the economy, but banks’ willingness to lend has been constrained because lending margins have been narrow and risk premiums small.

Banks in past cycles might have been willing to lend despite a relatively flat yield curve because they could enhance narrow lending margins by using leverage. However, regulations after the financial crisis now limit their ability to use leverage.

This policy and regulatory mix has fuelled some of the growth in private lending. Private lenders are not subject to regulated leverage constraints and can accordingly lend profitably despite a flat curve. The growth in private lending effectively reflects an unintended disintermediation of the traditional banking system. This has meant liquidity destined for the real economy has largely been trapped in the financial economy.

The yield curve has started to steepen, and the Fed should freely allow long-term interest rates to increase for monetary policies to benefit the real economy more fully. Allowing long-term rates to increase would not only begin to restrain financial speculation as risk-free rates rise, but could simultaneously foster bank lending to the real economy. 

Thus, the need for the Fed to Ferberise bond investors. Banks’ willingness to lend is starting to improve as the curve begins to steepen, but some economists are suggesting the central bank should continue its current strategy of lower long-term interest rates because of the potential for a disruptive “taper tantrum” by bond investors. The Fed needs to ignore investors’ tantrums and allow them to self-soothe.

The investment implications of the Fed allowing longer-term interest rates to rise seem clear. Much of the speculation within the US markets is in assets such as venture capital, special purpose acquisition vehicles, technology stocks and cryptocurrencies. These are “long-duration” investments that have longer-time horizons factored into their valuations. They underperform when longer-term rates rise because investors demand higher returns over time. Capital would be likely to be redistributed to more tangible productive assets.

Investors and policymakers should be concerned that monetary policy is fuelling speculation rather than supporting the lending facilities needed to rebuild the US’s capital stock and keep the country’s economy competitive.

Like a new parent to a baby, the Fed should not rush to coddle bond investors’ tantrums and should let the financial markets soothe themselves. Short-term financial market volatility might cause some sleepless nights, but the Fed could unleash the lending capacity of the traditional banking system by letting the yield curve steepen further.



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What we’ve learned from the Texas freeze

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One thing to start: While the freeze in Texas caused havoc for most, some companies have reaped big rewards. Australia’s Macquarie Group said yesterday full-year profits could rise by up to 10 per cent as a result of a surge in demand for its natural gas shipping business.

Welcome to today’s newsletter, where Texas remains in focus. In our first item, Derek Brower asks if oil’s modest price rise in reaction to last week’s events signals that the rally will soon run out of steam.

Further rises, after all, will only tempt America’s shale producers to dive into growth mode. For our second item, Justin Jacobs speaks to Devon boss Rick Muncrief about when the taps will be turned back on.

Elsewhere we round up the key reading on the Texas fallout from the FT and beyond; ask how the appointment of a general to head up Brazil’s Petrobras has gone down in the markets (hint: not well) and bring you the latest on the proxy battle to green ExxonMobil.

Thanks for reading. Please get in touch at energy.source@ft.com. You can sign up for the newsletter here. — Myles

Is the oil rally nearing the end of the road?

Texas’s cold snap last week lifted oil prices — yet still brought a warning for the market’s bulls. The Permian Basin, the world’s most prolific oil-producing region, froze up. US production fell by 2m barrels a day, according to Wood Mackenzie. Kpler, a data provider, estimates the country’s total output in February will be down by 1m b/d.

By Tuesday morning, after it emerged that producers would take weeks to fully restore flows, US oil futures were trading for around $62.50 per barrel, just $2.50 or so more than its price on the eve of the snowstorm. Hardly an Abqaiq-style oil-price leap.

One explanation is that huge volumes of refining capacity are offline too, removing a big source of demand and neutralising some of the supply disruption. But the market’s relative calm also begs questions about how resilient oil’s rally is — especially with an Opec meeting next week, when the cartel must decide how much, if any, of its 7m barrels a day or more of offline supply it will begin restoring.

Many analysts remain bullish. Goldman Sachs, Wall Street’s most influential oil-price forecaster, upped its expectations by $10 a barrel this week. It now expects Brent, which was above $66 on Tuesday morning, to hit $75 in the third quarter.

Line chart of US crude production showing The big Texan freeze

Yet the bull case increasingly depends on many things coming true at once, points out Neil Atkinson, an independent analyst who was formerly head of oil markets at the International Energy Agency. Sanctioned Iranian barrels must remain offline; US supply must remain constrained; and economies must rebound quickly. Above all, Opec must keep cutting.

Current prices are in a “sweet spot” for the cartel, said Atkinson. But any further price rises could prompt a response from shale (see below) and test Opec’s discipline, prompting a response from its biggest producer.

“Over the years, Saudi Arabia has shown its willingness to shift policy and maximise output if compliance falls and/or if the perceived costs of co-operation exceed the perceived benefits,” wrote Bassam Fattouh, head of the Oxford Institute for Energy Studies and a Saudi oil-policy expert, in an article explaining the kingdom’s recent decision unilaterally to deepen its owns cuts.

“Thus, Saudi Arabia can easily swing in the opposite direction in response to low compliance and given the relatively low level of Saudi production, the size of the upward swing could be quite substantial, as was the case in April 2020.”

(Derek Brower)

American oil market eyes production boost

After the oil-price surge of recent weeks, the big question hanging over the US shale patch, and broader oil market, is when American producers will start loosening the purse strings and opening up the taps.

That point might now be visible on the horizon. “If we do see commodity prices rapidly increase back to $70 or $80 a barrel, you’re going to be generating a lot of free cash and that gives you a lot of optionality on things you could think about,” Rick Muncrief, chief executive of Devon Energy, a major Permian producer, told ES last week.

For now, Muncrief’s company is keeping a 5 per cent cap on production growth and promising a windfall for shareholders if prices keep climbing. “First things first, we want to make sure we stay disciplined,” Muncrief said.

But his comments to ES point to when companies might ditch the capital discipline mantra and become more vocal about their ability to both accelerate output growth and keep cash flowing to shareholders.

Robert Kaplan, head of the Dallas Fed, also talked about the potential for oil producers to pivot away from capital discipline as prices rise. “I’ve learned sometimes if prices get high enough mindsets can change,” he told an International Energy Forum conference yesterday.

“To get back to 13m barrels a day, yes, you would need a change in mindset. Probably spurred by higher prices. Can I predict whether that will or won’t happen? No I can’t predict it, but I think we should be on watch for it,” Kaplan said.

We will get more of an idea of the mood in the shale patch later this week, after Pioneer Natural Resources, EOG Resources, Diamondback Energy, Occidental Petroleum and Apache have all reported earnings.

Expect a lot of talk about when producers might start getting back into the growth game. (Justin Jacobs)

What to read on the Texas freeze

A weeklong catastrophe left millions without power and heat amid some of the coldest weather the state has seen in a century.

The failure of the state’s electric grid caused immense human suffering, financial pain for consumers (and gain for some energy companies), and has spawned a wide-ranging conversation about where things went wrong and how to prevent it from happening again. Here are the key pieces to read:

  1. Start with Bloomberg’s in-depth account of the early hours of Monday morning, when the state’s grid operator, the Electric Reliability Council of Texas, was forced to plunge millions into darkness as power generation seized up.

  2. The International Energy Agency put the pieces together here in a broad overview of how the grid broke down — and points out that the lessons from Texas should be learned far and wide, especially as the world becomes increasingly electrified and vulnerable to disruptions.

  3. Gregory Meyer and I covered the financial fallout from the storm, including the story of one family in Burleson, Texas, which saw their electric bill suddenly spike to more than $8,000. We also explored who the winners and losers were in a $50bn bonanza of power trading.

  4. Some companies that cashed in on the crisis are being accused of profiteering. The gas producer Comstock Resources said surging natural gas prices were like “hitting the jackpot”.

  5. The crisis sparked an inevitable debate pitting renewables advocates against fossil fuel backers. This green versus brown debate generated much more heat than light. But the issue of intermittent renewables’ reliability is a critical one. The FT’s editorial board argued that frozen wind turbines were hardly the main cause of the grid’s collapse as the natural gas system, which has the largest share of the power market, also failed.

  6. A less sexy but probably more important issue is why so much of Texas’ energy system was so easily felled by temperatures that much of the rest of the country sees on a regular basis. This excellent Texas Tribune story looks at why “winterising” power plants, pipelines and wells might not be as easy or cheap as state officials hope.

  7. Finally, there is a fascinating debate over the role climate change did or did not play in the Arctic blast. My colleagues Leslie Hook and Steven Bernard have a nice explanation (and graphic) of how the jet stream bent south, covering Texas in freezing arctic air.

(Justin Jacobs)

Data Drill

Shares in Petrobras fell off a cliff yesterday as the market absorbed Brazilian president Jair Bolsonaro’s decision to oust the state oil group’s chief executive in favour of a general.

Bolsonaro had blamed Petrobras’s erstwhile boss Roberto Castello Branco for recent rises in petrol and diesel prices, which had provoked the ire of the country’s truck drivers.

Strikes over fuel costs in 2018 paralysed Brazil’s economy and sapped support for the government, helping secure Bolsonaro’s election to office.

Line chart of Share price (Brazilian reals) showing Petrobras shares plunge after Bolsonaro ousts CEO

Power Points

Endnote

The proxy battle at ExxonMobil rumbles on, with activist group Engine No.1 blasting the oil major’s assertion that its carbon-cutting plan was in line with the Paris accords.

Exxon has stuck to its guns as an oil producer even as rivals like BP and Shell lay out plans to shift into greener sources of energy and reduce fossil fuel output. But it has made concessions in the face of investor pressure, including pledges to cut emissions intensity by 2025.

This month the company said that its emissions targets were “projected to be consistent with the goals of the Paris agreement” and would position it to be “an industry leader in greenhouse gas performance by 2030”.

Engine No.1, which wants to install four new energy-transition-focused directors on Exxon’s board, was having none of it. In a letter to the board yesterday, it wrote:

“None of the company’s new claims change its long-term trajectory which would grow total emissions for decades to come. This is not consistent with, but rather runs directly counter to the goals of the Paris agreement.”

Exxon did not respond to a request for comment.

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Global stocks fall on nerves over inflation outlook

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Global stocks sank and commodities rallied as concerns over the inflation outlook continued to undermine investor confidence.

The blue-chip S&P 500 index was down 0.3 per cent in the afternoon in New York while the technology-focused Nasdaq Composite lost 1.6 per cent.

A sell-off in US government bonds — whose returns are eroded by inflation — picked up again after taking a breather earlier in the day. The yield on the 10-year Treasury note, which moves inversely to price, was up 0.03 per cent, at 1.37 per cent, by the afternoon in New York.

Overnight, the yield on the benchmark note had come just shy of 1.4 per cent, before retreating to 1.33 per cent in the morning.

The 10-year yield started the year just above 0.9 per cent, but has risen consistently with predictions that US president Joe Biden’s proposed $1.9tn fiscal stimulus package will feed through to faster price rises.

“The main concern is related to the prospect of increased inflation,” said Tancredi Cordero, chief executive at the advisory firm Kuros Associates. “There’s a lot of concern amongst investors in fixed income and businesses that are sensitive to that.”

Such worries hit Asian markets on Monday, where Japan’s 10-year government bonds rose 0.01 percentage points to 0.13 per cent, while in Australia its 10-year yield hit 1.61 per cent, its highest level since June 2019.

“The rise in global yields is a reflection of improved growth prospects given encouraging vaccine progress and in the US forthcoming sizeable fiscal stimulus,” said Gurpreet Gill, macro strategist at Goldman Sachs Asset Management.

[It] also signals higher inflation expectations and in turn pulled forward expectations for the timing of monetary policy normalisation.”

The big question is whether rising inflation will push the Federal Reserve away from its path of ultra-loose monetary policy. Investors will watch closely Jay Powell’s semi-annual testimony to the Senate banking and House of Representatives financial services committees on Tuesday and Wednesday to see if the Fed chairman provides clues as to the direction the US central bank will take.

These would be “important events”, said Jim Reid, research strategist at Deutsche Bank.

In Europe, the region-wide Stoxx 600 closed down 0.4 per cent on Monday following three consecutive weekly gains. London’s FTSE 100 benchmark fell 0.1 per cent while Frankfurt Xetra’s Dax was down 0.3 per cent.

Oil prices continued to rally, meanwhile, on hopes of growing demand for fuel as the global economy reopened following the rollout of Covid-19 vaccines. Crude was also viewed by some investors as a hedge against inflation.

Brent crude, the international benchmark, rose 3.6 per cent to $65.15 a barrel, while West Texas Intermediate, the US marker, added 3.8 per cent to $61.49 a barrel.

Copper gained as much as 3.7 per cent to hit a 10-year high of almost $9,300 a tonne in early trading on Monday, driven by reports that China’s largest copper smelter was reducing output. The price later eased to about $8,985 a tonne.

Elsewhere, nickel moved above $20,000 a tonne for the first time since 2015 following a deadly accident over the weekend at a processing plant owned by Nornickel, the world’s biggest producer of the metal. Like copper, nickel pared early gains and was trading at about $19,330 a tonne by the afternoon.

Alastair Munro at brokerage Marex Spectron said industrial metals had also been boosted by the first official statements of 2021 regarding China’s economy.

Articles in Xinhua and other official news outlets discussed strengthening rural infrastructure and modernising agricultural production methods to spur consumption, he said. Such signs of significant growth plans “look set to be a new driver of China’s economy over the next few years”, he added.

In Asia, China’s CSI 300 index fell 3.1 per cent, its biggest one-day drop since last summer, as concerns grew of a gradual tightening in lending conditions. Hong Kong’s Hang Seng lost 1.1 per cent and South Korea’s Kospi 200 dropped 0.9 per cent. Japan’s Topix gained 0.5 per cent.



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