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Time to look again at the financial system’s dangerous faultlines



The writer is chair of the Systemic Risk Council and author of “Unelected Power”

The west cannot afford another financial crisis. It would be a disaster in every possible way domestically, and a geopolitical gift to strategic competitors in Beijing and elsewhere.

Last March and April, the fabric of our financial system was stretched almost beyond endurance. Only intervention from the north Atlantic central banks seems to have averted some kind of disaster triggered by markets grasping the pandemic was serious.

One can more than quibble over the gigantic scale of central banks’ bond purchases and their fuzzy explanations, but problems in monetary politics should not distract from the imperative of ensuring the system proves more resilient in future.

Many describe the US Treasury market as the most liquid capital market in the world. It would be more accurate to say that, for the dollar’s place as the world’s premier reserve currency to be secure, trading in Treasuries must remain reasonably liquid in all weathers. The same goes for government bond markets on the European side of the Atlantic.

Three things are needed to tackle this part of the backlog of unfinished or neglected business for safeguarding stability. First, central banks need to dust down the plans developed a decade ago for them to act as market makers of last resort — buying and selling securities, subject to an insurance premium — when trading liquidity evaporates.

You don’t need to buy the whole of a market to underpin its liquidity, as Mario Draghi demonstrated in 2012 when he declared the European Central Bank would “do whatever it takes” to deter the run on sovereign debt markets. Acting as the market maker of last resort is not the same as using quantitative easing to stimulate spending in the economy, or buying bonds to peg debt-servicing costs. It is about restoring liquidity by acting as a backstop buyer and seller, not targeting a particular price.

Second, the plumbing and design of the main government bond and bond-lending markets need repairs, and possibly overhauling, if they are to cope with today’s extraordinary occasional bursts in selling activity. Maybe, as Stanford economist Darrell Duffie has proposed, all transactions in government bonds should be processed through central clearing houses.

But since many clearing houses are now super-systemic, authorities should contemplate that solution only if, at long last, they grasp the nettle of how to resolve a distressed central counterparty without a taxpayer bailout. This is a painful piece of badly needed reform. 

Third, and most significantly, the spectre of excessive leverage and liquidity mismatches among some types of funds and other investment vehicles really must now be addressed.

Banking’s historical fragility is being replicated outside the industry, and without constraints or backstops. In general terms, this was foreseen: the re-regulation of banking after the 2008-09 collapse was obviously going to incentivise activity to migrate elsewhere.

There were plans to develop policies for such shadow banking, distinguishing it from the vanilla capital markets activity that does not represent a threat to the resilient provision of essential credit, insurance and payments services. But the plans stalled, and when the shadow banking label was ditched for the much more positive sounding “market-based finance”, the issue was, in effect, whitewashed. 

Last October, the Systemic Risk Council, a group of former top central bankers and regulators, academics and others, published proposals for reforms to ensure a stable financial system. The 2008 market meltdown triggered by the dramatic failure of the investment bank Lehman Brothers gripped the public, fuelling demands for reform. But the March 2020 near-miss has passed most people by.

Led by incoming US Treasury secretary Janet Yellen, authorities, including legislators, need to get on with it. The system is less resilient than claimed, and many know it. Legislators should use forthcoming confirmation and oversight hearings, on both sides of the Atlantic, to demand that incoming and incumbent officials and regulators commit to tackling these dangerous faultlines.

So democratic leaders, please do what only you can do: inject public energy into this. More prosaically, demand that substantive progress be reported to the next G20 summit. And central bankers, market regulators and prudential supervisors, act decisively whether or not elected power stirs itself. A near miss was a peculiar kind of blessing — don’t let it go to waste. 

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European stocks stabilise ahead of US inflation data




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




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




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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