In Office Reply
From Bloomberg today:
More than half of workers in major US cities went to the office last week, the first time that return-to-office rates crossed 50% of their pre-pandemic levels.
And from Friday’s edition of the San Francisco Chronicle:
San Francisco, and the entire Bay Area, lost population during the second year of the pandemic, and California’s population continued to fall for the third year in a row, according to state estimates released Thursday.
The city’s population was an estimated 834,046 people as of July 2022, down from a pre-pandemic high of 889,783 people in January 2020. It was the lowest level since July 2012 as out-migration wiped out seven years of sustained growth fueled by the tech boom. 
Sisyphean Ask
He’ll bring Mr. Market to heel or retire trying.
He’ll bring Mr. Market to heel or retire trying. Outgoing Bank of Japan governor Haruhiko Kuroda stuck to his guns in an address to parliament this morning, reiterating the need for an ultra-easy monetary stance to “support the economy and create an environment where companies can raise wages.” In service of that goal, the BoJ steadfastly maintains sub-zero benchmark borrowing costs, while undertaking unlimited purchases of 10-year Japanese government bonds north of a 0.5% yield to prevent borrowing costs from exceeding that threshold. 
Of course, something resembling success on that front is now readily apparent, as the inflationary dynamic that has swept through much of the globe is increasingly evident in the Land of the Rising Sun. Core CPI in Tokyo advanced at a 4.3% annual clip in January, government data released Friday show, accelerating from 3.9% in December and marking the hottest reading since 1981, after a nationwide gauge grew by 4% year-over-year in December, double the BoJ’s long pined-for target. Meanwhile, economists at Goldman Sachs reckon that unionized firms will achieve a 2.8% annual increase in wages during this spring’s annual negotiations. That compares to a prior 2.5% guesstimate and would represent the fastest such pace since 1993. 
“Economists including myself have to admit the fact that [price data] have been beating our expectations, which means that our views are influenced by the past norm of inflation,” Nobuyasu Atago, former BoJ official turned chief economist at Ichiyoshi Securities, told Bloomberg Friday. “Now I see a chance that inflation may peak at a higher level and become stickier than I had expected.”
As Kuroda forges ahead with his grand experiment during the final three months of his term, other Japanese policymakers are expressing reservations. Earlier today, an advisory panel of business and academic luminaries collectively urged a course correction, proposing that the BoJ tweak its 2% inflation bogey to represent a long-term guidepost rather than a figure that should be reached as soon as possible.
“The way the BoJ conducts monetary policy must be revamped,” commented panelist Yuri Okina, while peer Nobuyuki Hirano warned that Kuroda’s experiment was fomenting trouble in local fixed-income markets: “Given such distortions, we must correct the BoJ’s policy into one that is more flexible. It’s too dangerous to keep going this way.” 
Evidence of sub-optimal market functioning is not hard to come by, with investors increasingly willing to call the BoJ’s bluff. The ostensibly yield-capped 10-year JGBs have repeatedly breached that 50-basis point line in the sand in recent weeks, forcing the central bank to shell out $265 billion, or more than 6% of last year’s nominal GDP, to defend that threshold during the four weeks through mid-January.  As a result, Bloomberg relayed last Wednesday that the BoJ now owns more than 100% of four separate JGB issues, achieving that peculiar feat by lending out the securities – in the name of enhancing liquidity – to investors who subsequently sold short the bonds back to the central bank. 
Similarly, the index provider FTSE Russell announced last week that it has removed a pair of JGB issues from its World Government Bond Index, with two more slated for the chopping block next month, as those securities fell short of the FTSE’s minimum requirements for outstanding supply held by the investing public. 
Japan’s primary corporate bond market likewise evinces growing investor doubt over the durability of Kuroda’s rate suppression regime: Issuance of  yen-denominated notes maturing in five years or fewer jumped to ¥527 billion ($4.1 billion) in the month-to-date through last Wednesday, data from Bloomberg show, up 94% from last year’s pace, as those shorter tenors would suffer less of an impact were the BoJ forced to turn tail on its yield-curve control policies. For context, new supply of corporate bonds maturing within five years grew by 3% on a global basis over the same period. 
“The situation has been developing in the totally opposite direction” from how the BoJ had hoped, SMBC Nikko chief rates strategist Chotaro Morita wrote last week. “The BoJ will have no choice but to abolish the yield target sooner or later.” 
Might a BoJ pivot signal a new era in worldwide monetary policy? See the analysis “Eliminate the negative” in the Jan. 13 edition of Grant’s Interest Rate Observer for more on central bankers’ capitulation to market forces, and the investment implications therein. 
Recap Jan. 30
Stocks began the week in bearish fashion as the S&P 500 lost 1.3% and the Nasdaq 100 retreating by 2%, while Treasurys saw another round of bear flattening with 2- and 30-year yields rising to 4.25% and 3.66%, respectively, up six and two basis points on the session. Gold pulled back to $1,939 an ounce, WTI crude slipped to $78 per barrel and the VIX climbed a point and change to settle just below 20. 
- Philip Grant
Slow Hand
From NBC affiliate WLFA in Tampa, Fla: 
One lucky Florida man credited another person’s behavior for winning a $1 million prize playing a scratch-off lottery game. 
“It was the end of a long day, and I was tired,” 43-year-old Delray Beach resident Stephen Munoz Espinoza told the Florida Lottery. “I stopped at Publix and was about to buy a ticket at the machine when a man cut right in front of me.”
Instead of saying something, Espinoza said he decided to buy a 500X the Cash scratch-off ticket at the counter . . . [where] players have a 1 in 267,739 chance of winning $1 million.
Return to the Planet of the Apes
The juice isn’t always worth the short squeeze.
The juice isn’t always worth the short squeeze. Debt restructuring looks to be in the cards for Bed Bath & Beyond (ticker: BBBY), as the stricken home goods retailer disclosed in a filing yesterday that it “does not have sufficient resources to repay” lenders including JPMorgan Chase & Co. and has received a notice of default from the bank. A separate filing Thursday noted that restructuring expert Carol Flaton will join the board as an independent director, at a $30,000 monthly salary “payable in cash in advance.” 
Bed Bath, encumbered by $550 million in asset backed loans, along with $375 million credit facility and $1 billion in unsecured bonds, reported holding $154 million in unrestricted cash and cash equivalents as of Nov. 26. The firm, which posted a $1.12 billion net loss on $4.16 billion in sales over the nine months through that date, faces scheduled interest payments next Wednesday on those senior unsecured bonds. Bed Bath’s 5.165% notes of 2044 last changed hands at 6.5 cents on the dollar, while Bloomberg relays this afternoon that efforts to find a buyer have stalled, leaving a corporate liquidation an increasingly likely prospect. 
Inconvenient details aside, BBBY shares managed a 1.2% gain on the day to leave its market capitalization at $299 million. The company commanded a near $2 billion equity valuation as recently as August, even though that 2044 obligation then traded near 20 cents on the dollar, an unmistakable signal from the bond market that bankruptcy (which typically wipes out shareholders) was in the offing. 
Helping to explain that yawning disparity: BBBY’s status as a darling of the so-called meme stock crowd, the Reddit-centric retail trading contingent that stormed onto the scene during the pandemic lockdowns. 
Firms favored by the self-described “apes” have enjoyed no minor benefit from that association. The Financial Times documents today that the eight companies most closely associated with the craze have collectively raised nearly $5 billion over the two years, a dynamic that has allowed firms like GameStop to transform their balance sheet: After garnering a cool $1.8 billion from share offerings over the past two years, the video game retailer sported a $468 million net cash position as of October, compared to $690 in net debt in 2020.  
“Some bubbles do not really translate themselves into the real economy, but some bubbles do,” Itay Goldstein, professor of finance at the University of Pennsylvania’s Wharton business school, told the FT.
Indeed, the meme stock movement has made its mark on at least one corner of Wall Street. Bloomberg reported earlier this month that Citadel Securities (the market making arm of Ken Griffin’s hedge fund behemoth) generated a record $7.5 billion in net trading revenues across 2022, topping the $7 billion achieved during the prior year, as the firm has managed 12 straight quarters with at least $1 billion from that activity. Citadel, which says that it handles roughly 25% of all U.S. trading volume, is especially active within the retail crowd, claiming a 40% market share. 
Recap Jan. 27
Stocks lost some altitude late in the session, but still managed another green finish as the Nasdaq 100 enjoyed a 4.5% advance for the week, its best such showing since November.  Treasurys came under modest pressure with two- and 30-year yields each rising two basis points to 4.19% and 3.64%, respectively, while WTI crude slipped below $80 a barrel, gold held at $1,929 per ounce and the VIX settled at 18.5 after testing 18 this morning. 
- Philip Grant
Tomorrow is Forever
From the New York Times
The price for first-class Forever stamps increased to $0.63 from $0.60 this week, a 5% jump that stemmed from rising operating expenses and losses for the Postal Service.
The last price increase was in July, when the price of a first-class stamp for a one-ounce letter rose. . . from $0.58. Before [that] increase, the stamps cost $0.55.
When it was first introduced in 2007, the Forever Stamp cost $0.41.
Earth Play
Heading south, down Mexico way:
Heading south, down Mexico way: creditors of Petróleos Mexicanos (Pemex) had a rough go of it yesterday, as the firm’s dollar-pay 6.5% bonds due 2041 tumbled as much as 2.3 cents to 70.6. That selloff, one of the worst across the high-yield market, following a Bloomberg report that Pemex will soon issue upwards of $2 billion in fresh debt to help cover the near $6 billion in amortization payments due by the end of March. 
“We are getting to the point where the indebtedness of the company is getting outrageous,” Luis Maizel, co-founder of LM Capital Management, tells Bloomberg. Indeed, Pemex sports the dubious distinction of the world’s most encumbered energy firm, toting a cool $105 billion in financial debt as of the end of the third quarter. 
Operating results, too, leave something to be desired. Pemex logged a $2.58 billion net loss over the three months through September and has posted negative free cash flow in each year since at least 2012, burning through a cumulative $86.8 billion over that stretch. Crude oil output remained stuck at 1.764 million barrels per day during the third quarter, barely half of the 3.4 mbpd achieved during the 2004 glory days. 
Since a bearish analysis in the March 23, 2018 edition of Grant’s Interest Rate Observer identifying an unhealthy codependency between the oil giant and the Mexican state, Pemex’s 6.5s of 2021 have widened to a 636-basis point spread over Treasurys from 363 basis points, while the firm’s credit default swaps sit north of 500 basis points, triple their early 2018 level. 
For now, at least, Pemex’s beleaguered lenders are on their own, as the Mexican government led by President Andrés Manuel López Obrador signaled that further financial assistance won’t be forthcoming any time soon after bequeathing a series of tax breaks and cash infusions in recent years. Mexico faces a budget deficit equivalent to 3.5% of GDP this year if analysts at Bloomberg are on target, which would be the widest such shortfall since 2015. Back in July, Moody’s downgraded the country’s sovereign rating to triple-B from triple-B-plus, citing “increased expenditure rigidity related to recurrent support to state-owned enterprises.”
Of course, it’s a different story a few hundred miles to the north, as the U.S. oil service industry enjoys the fruits of the post-Covid energy bull market. On Tuesday, Houston-based Halliburton Co. (ticker: HAL) reported fourth quarter earnings of $0.72 per share, double last year’s tally and topping the $0.67 analyst consensus, as revenues jumped 31% year-over-year to $5.58 billion. Sporting a 19.8% operating margin, its fattest since 2015, Haliburton undertook $250 million in share repurchases during the period and announced a 33% quarterly dividend hike to $0.16 per share, while management articulated plans to pay out half of free cash flow to investors.
Those shareholders have enjoyed a 48% total return since HAL featured as a pick-to-click in the Jan. 21, 2022, edition of Grant’s Interest Rate Observer, just shy of the 53% logged by the Van Eck Oil Services ETF but lapping the negative 7% return for the broad S&P 500. Recent strength aside, the “current price still offers a reasonable entry point for new money,” analysts at Benchmark Securities believe. 
“Everything I see today points to continued oil and gas tightness,” commented Halliburton president and CEO Jeff Miller. “It’s clear to me that oil and gas is in short supply, and only multiple years of increased investment in both. . . will solve short supply.”
In that belief, the Halliburton head has plenty of company. The Federal Reserve Bank of Dallas’ fourth quarter energy survey found that 64% of respondents plan to increase their capital spending in 2023, with 25% of the 148 firms polled “anticipat[ing] a significant increase.” In contrast, only 14% expect capex spending to decline, with most of that cohort foreseeing only a modest downtick. 
Industry heavyweight Schlumberger Ltd., now doing business as SLB, is likewise reaping the rewards of a secular tailwind, as the world’s largest oilfield services outfit churned out $0.74 in fourth quarter EPS and $7.9 billion in revenues, up 76% and 27% year-over-year, respectively, while increasing its quarterly dividend to $0.43 a share, a 43% bump. CEO Olivier Le Peuch sees blue skies ahead, stating that “activity growth is expected to be broad-based” this year, while “pricing continues to trend favorably.” 
A small fly in the ointment: SLB noted in its form 10-K that it still awaits $1 billion from “its primary customer in Mexico.” That same, unnamed entity accounted for $500 million in receivables this time last year.  
QT Progress Report
Reserve Bank Credit declined by $20.5 billion from a week ago, leaving the Fed’s portfolio of interest-bearing securities at $8.45 trillion. That represents a 5.3% decline from the March 2022 high-water mark and sits $80 billion below the year-end holdings. 
Recap Jan. 26
The bulls stayed in command as stocks garnered another 1.1% advance on the S&P 500 to leave the broad index higher by nearly 7% for January. Treasurys came under bear flattening pressure with the two-year yield rising six basis points to 4.17% while the long bond held at 3.62%, WTI crude rose above $81 a barrel and gold saw a modest pullback at $1,930 per ounce. 
- Philip Grant
Double Cross
Turn those machines back on! From The Wall Street Journal:
An apparent glitch at the New York Stock Exchange on Tuesday briefly caused wild price swings and a temporary trading freeze in stocks of major companies such as Exxon Mobil Corp., McDonalds Corp. and Walmart Inc.
The NYSE said in a notice to traders that it was investigating a reported issue with its opening auction, the critical process at 9:30 a.m. ET each day that determines the official, beginning-of-day prices for stocks listed on the exchange.
“It’s a real mess,” said Dennis Dick, founder of Triple D Trading, a proprietary trading firm. “I’ve traded for 22 years, and I’ve never seen the opening cross at NYSE go haywire.”
Coming and Going
Mr. Market is having a party, and everyone’s invited.
Mr. Market is having a party, and everyone’s invited.  The stark bullish turn in conditions that have accompanied the new year has ushered in a reprieve for various players laid low by a bruising 2022.  Let’s review some particulars:
The bottom of the barrel in corporate credit rules the roost: the triple-C-rated component of the Bloomberg High Yield Index garnered a 5.24% total return this month through Friday, well outpacing the 3.5% logged across the broad junk gauge and marking the category’s best start to the year since 2003.  Average yields likewise plunged 150 basis points to 12.76%, the biggest such drop since 2001.  
High-yield issuers have duly responded to that spasm of euphoria, as nine separate deals priced last week for a total of $6.7 billion, the busiest one-week stretch since January 2022, when the stock market was near its peak. Year-to-date supply reached $14.5 billion as of yesterday, a nice start given last year’s anemic $101.8 billion total.  
Perhaps most tellingly, investors are waving in opportunistic transactions that would have arguably been relegated to pipe dream status during last year’s selloff. To wit: single-B-plus/single-B-rated Caesar’s Entertainment Inc. priced a $2 billion sale of high-yield bonds due in 2030 along with a $1.75 billion leveraged loan to help refinance existing debt maturing in December 2024, managing to upsize the fixed-rate tranche from a planned $1.25 billion at a 7% yield. That’s not only inside initial price talk of about 7.5%, but also well below the average 8.34% on offer across single-Bs. 
Then, too, Bloomberg reported yesterday that retailer Savers LLC is marketing $500 million of five-year, senior secured notes, with proceeds earmarked to pay down an existing loan as well as to help fund a dividend for private equity sponsors Crescent Capital Group and Ares Management Corp. The pair took ownership of the thrift store chain from peers Leonard Green & Co. and TPG in a 2019 out of court restructuring in which the buyout firms collectively chipped in $165 million.
It's not just those within speculative-grade credit enjoying the abrupt turn in financial conditions, as an avatar of the pandemic-era bull stampede steals a glimpse at the good old days. The ARK Innovation ETF (ticker: ARKK) has logged a cool 22% January advance through Monday, putting the vehicle on pace for its third-best monthly showing behind only 24% and 26% returns seen during the post-March 2020 melt-up.  That impressive rally offers a measure of reward for the innovation-focused fund’s hearty legion of admirers, who poured a net $1.5 billion into ARKK last year, equivalent to 20% of assets under management, though shares remain 75% south of the February 2021 high-water mark.
Yet as investors and speculators alike toggle from despair to euphoria, some less-than welcome changes look to be afoot within the economy at large. This morning’s release of S&P Global’s flash purchasing managers index for January indicated contracting activity for a seventh consecutive month. At the same time, S&P finds that input prices logged a sequential increase, the first such instance since May. 
“Companies cite concerns over the ongoing impact of high prices and rising interest rates, as well as lingering worries over supply and labor shortages,” S&P’s chief business economist Chris Williamson relayed in a statement. “The worry is that, not only has the survey indicated a downturn in economic activity at the start of the year, but the rate of input cost inflation has accelerated into the new year, linked in part to upward wage pressures, which could encourage a further aggressive tightening of Fed policy despite rising recession risks.”
One corporate bellwether likewise sounds the alarm: Sprawling conglomerate 3M Co. projected full-year earnings per share ranging from $8.50 to $9 today, well below the $10.20 that Wall Street expected, while announcing that it will cut 2,500 manufacturing jobs in the first quarter, equivalent to some 3% of its global workforce. 
CEO Mike Roman attributed that shortfall to “rapid declines in consumer-facing markets such as consumer electronics and retail, a dynamic that accelerated in December as consumers sharply cut discretionary spending and retailers adjusted inventory levels.”
Recap Jan. 24
Stocks finished just south of unchanged on both the S&P 500 and Nasdaq 100, though Treasurys caught a solid bid across the curve, highlighted by a notably strong two-year note auction this afternoon. WTI crude retrenched to $80 a barrel, gold rose to $1,938 an ounce for its best finish since April and the VIX slipped towards 19. 
- Philip Grant
Value Added?
An excerpted press release today from the SEC:
The Securities and Exchange Commission today announced settled charges against Bloomberg Finance L.P. (Bloomberg) for misleading disclosures relating to its paid subscription service, BVAL, which provides daily price valuations for fixed-income securities to financial services entities.
The SEC’s order finds that from at least 2016 through October 2022, Bloomberg failed to disclose to its BVAL customers that the valuations for certain fixed-income securities could be based on a single data input, such as a broker quote, which did not adhere to methodologies it had previously disclosed.
Rabble Yell
Hope springs eternal across Western financial markets,
Hope springs eternal across Western financial markets, as investors collectively expect that last year’s inflationary tidal wave will recede sooner rather than later. As The Wall Street Journal details today, Treasury notes maturing in one year sport roughly a 4.7% yield while inflation-protected securities coming due the same month yield about 2.7%, suggesting that markets anticipate a 2% headline CPI by January 2024. Similarly, swap contracts tied to the CPI now point to headline increases of 2.1% over the next year. 
Coming on the heels of a peak 9.1% pace in June, that anticipated deceleration recalls the dynamic seen between August 2008 and July 2009, when CPI collapsed to minus 2.1% from positive 5.6% less than one year earlier. “There is a lot of hope embedded in market expectations of a rapid decline in inflation,” Eric Winograd, senior economist at AllianceBernstein, tells the Financial Times
In contrast, central bankers anticipate a more protracted battle after 2022 ushered in the most acute price pressures seen in 40 years. “We do not want to be head-faked,” Fed governor Christopher Waller stated Friday. “Inflation is not going to just miraculously melt away. It’s going to be a slower, harder slog to get inflation down, and therefore we need to keep rates higher for longer.”  The rate setting Federal Open Market Committee will convene for its two-day policy meeting next Tuesday, with a 25 basis point rate likely in the cards.
Tough talk is likewise emanating from Frankfurt, as European Central Bank President Christine Lagarde declared from Davos Thursday that inflation remains “way too high” and that “we shall [remain in] restrictive territory for long enough so that we can return inflation to 2% in a timely manner.”  Referencing the decline in annual headline CPI to 9.2% year-over-year in December from 10.6% two months earlier, fellow Governing Council member Klaas Knot dismissed notions of easier policy as a result: “that [drop] was entirely due to base effects and lower energy inflation. We focus on core inflation where, unfortunately, there is no good news.” With the ECB set to render its next policy decision next Thursday, Knot declared that a downshift from Lagarde’s projected 50-basis point pace of rate hikes “is not in sight for the upcoming meetings.” 
Perhaps informing that newfound hawkishness after an eight-year experiment with sub-zero borrowing costs: the prospect of a vicious inflationary cycle driven by rising employee compensation. A white paper posted on the ECB website earlier this month found that, thanks to the recent explosion in prices, “real consumer wages are now substantially lower than before the pandemic,” a development that “could lead trade unions to demand higher wage increases in upcoming negotiation rounds.” Accordingly, “wage growth over the next few quarters is expected to be very strong compared with historical patterns, [reflecting] robust labor markets that so far have not been substantially affected by the slowing of the economy, increases in national minimum wages and some catch-up between wages and high rates of inflation.”
The monetary mandarins have first-hand knowledge of that dynamic. Citing a survey of ECB staffers by trade union IPSO, Reuters reported Wednesday that some two-thirds of the 1,600 respondents said their faith in senior leadership has been damaged by surging prices, while 63% expressed doubt over whether the ECB could protect their purchasing power after receiving pay increases of just under 4% last year, or roughly half the measured increase in CPI.  “We’re not happy,” Carlos Bowles, vice president of IPSO, told Bloomberg last month. “If a negotiated approach to find a compromise continues to be rejected by the ECB, we will have to consider protest actions early [this] year.” 
Recap Jan. 23
Stocks caught another strong bid as the S&P 500 jumped 1.2% to reach a new high-water mark for January with a 5.2% advance, while Treasurys came under moderate pressure with two-year yields rising seven basis points to 4.21% and the long bond ticking to 3.69% from 3.66% Friday. Gold edged higher to $1,933 an ounce, WTI crude held just below $82 a barrel and the VIX settled slightly south of 20. 
- Philip Grant
All in the Family
From legal industry news service NYLaw360:
A Delaware bankruptcy judge Friday approved the appointment of Sullivan & Cromwell, which had come under fire from several directions and from members of Congress, as Chapter 11 counsel for FTX, dismissing arguments by a pair of FTX customers that the firm was conflicted because of its prior work for the cryptocurrency exchange.
Almost Took a Haircut
The road goes on forever, and the party never ends.
The road goes on forever, and the party never ends. Bain Capital senior advisor Stephen Pagliuca sees blue skies ahead for the buyout industry, declaring to Bloomberg Television from Davos Wednesday that the private equity’s ascent remains in the “early innings,” with 18% to 20% rates of return on tap over the coming decades. “The private equity model works,” he added.  
Carlyle Group co-founder David Rubenstein struck a similarly upbeat tone from the Swiss Alps this morning, telling the former NYC mayor’s TV network that, although “there were fewer deals getting done last year than we would have liked” as asset prices retreated and recession concerns proliferated, “this year, I suspect, will be better.”  
To be sure, the buyout barons weren’t exactly sitting on their hands in 2022, as private equity consummated $1.01 trillion worth of deals in the U.S., data from PitchBook show, south of the $1.26 trillion logged in 2021 but far above the pre-pandemic high water mark of $760 billion seen during 2019.  
Fancy price tags accompanied that healthy deal slate, as the median buyout took place at an enterprise value equivalent to 3.1 times revenue, compared to just 1.1 times EV to sales during the prior p.e. heyday in 2007. Helping to facilitate those rich valuations, an extra dollop or two of leverage: the median buyout featured a 5.9 times debt to Ebitda ratio last year, compared to just 5.1 turns in 2012 (recall that the Federal Reserve, Office of the Comptroller of the Currency and Federal Deposit Insurance Corporation issued guidance in 2013 discouraging borrowers from carrying 6 or more turns of leverage). 
Needless to say, today’s backdrop now bears little resemblance to the conditions that largely prevailed in the post-crisis era, as benchmark interest rates now sit north of 4% after a near uninterrupted dozen year stretch close to zero. That rapid shift is, of course, no manna for leveraged loans, the $1.4 trillion collection of floating-rate and speculative grade tradeable bank debt that is dominated by p.e.-sponsored firms (accounting for 60% of the market per PitchBook).  Newly issued leveraged buyout loans came to market at all-in yields of roughly 10% by the fourth quarter, more than double that seen at the start of 2021, while spreads crept to 500 basis points from less than 400 basis points over the same period.
Sure enough, credit quality is rapidly on the wane, as downgrades outpaced upgrades by a 2.77 to 1 clip over the three months through December, LCD finds. That ratio was 1:1 as recently as May, while upgrades predominated at a 2:1 spread in the fall of 2021. Similarly, nearly 8% of constituents in the Morningstar LSTA Leveraged Loan Index changed hands below 80 cents on the dollar (a level that typically implies distress) by year-end, compared to just 2% in January 2022. 
Any extended stretch of elevated borrowing costs could inflict substantial pain, S&P warned on Wednesday. At particular risk: the (p.e.-heavy) business and technology services group, “given [the] significant proportion of highly leveraged speculative-grade borrowers.” The rating agency relays that roughly half of the 93 single-B and single-B-minus rated firms that it tracks within that cohort chose not to hedge their interest rate exposure through derivatives. As a result, interest expense among those unhedged firms will jump over 40% on average in 2023 from 8% a year ago, while Ebitda will cover interest expense by a relatively thin 1.6 average margin this year, compared to 2.3 times in 2022, S&P reckons. 
Then, too, questionable use of proceeds among large swaths of leveraged loan borrowers could further complicate matters in the event of an extended spell of rough financial weather.  An analysis this week from advocacy group Americans for Financial Reform finds that a mere 3% of total loan proceeds from 2014 to 2019 went towards business investment. In contrast, 38% of those borrowings helped fund acquisitions and leveraged buyouts, 51% refinanced existing debt and 8% went to so-called dividend recaps, or debt-funded paydays for the issuer’s p.e. sponsor.
In any event, private equity’s future may be bright enough to require shades, but Bain’s Pagliuca (the executive quoted above) won’t be directly reaping the rewards. The 68-year-old announced his retirement last month. 
Recap Jan. 20
Monthly options expiration suited the bulls just fine, as stocks roared higher by nearly 2% on the S&P 500 to crawl back to near-unchanged for this abbreviated trading week.  Treasurys had a rougher go of it, with the two-year rising to 4.14% from 4.09% a day ago and the long bond settling at 3.66% compared to 3.57% (yesterday’s ADG erroneously pegged those closing yields at 4.41% and 3.97%, respectively), while WTI crude tested $82 a barrel and gold continued higher to $1,925 per ounce. The VIX retreated to just below 20. 
- Philip Grant
Pie in the Buh-bye
Talk about foaming the runway. From the Financial Times:
Founders Fund, the venture capital firm co-founded by billionaire Peter Thiel, closed almost all of its eight-year bet on cryptocurrencies shortly before the market began to crash last year, generating about $1.8bn in returns.
In April 2022, about the same time that Founders Fund sold out of most of its cryptocurrency holdings, Thiel said he was optimistic about the future of bitcoin. He told a cryptocurrency conference in Miami that “we’re at the end of the fiat money regime” and suggested its price — which was then trading at about $44,000 — could increase by a factor of 100.
Leaving those gains for the next generation of investors: a civic-minded spirit rarely seen on Wall Street. 
The Staple Singe
We’ll make it up on. . . price?
We’ll make it up on. . . price?  Consumer products heavyweight Procter & Gamble reported $20.77 billion in net sales over the three months through December, not far from the sell side consensus $20.74 billion, but down 1% from a year ago to represent the first such top-line decline in more than five years.  The near 200-year-old company likewise tweaked its forecast for organic revenue growth (a figure that strips out the effects of currency fluctuations) during the year ending in June to 4.5% from 4%, using the midpoint of the respective ranges, though analysts at Wells Fargo note that the revised guidance implies a deceleration in organic sales to 3% over the next two quarters from a 6% rate since July 1.  
Yet an instructive dynamic stands out from those seemingly routine results: P&G absorbed a 6% year-over-year decline in organic volume growth during the quarter, more than double Wall Street’s expected 2.6% retrenchment, as each of the household product purveyor’s five segments saw volumes contract. In turn, Procter pulled the pricing lever to the tune of a 10% annual increase, well above the 6.7% consensus.  As that unexpected divergence suggests, the current backdrop remains “a very difficult cost and operating environment” CEO Jon Moeller stated in the earnings release, while CFO Andre Schulten added on the conference call that “these macroeconomic and market-level consumer challenges we're facing are not unique to P&G and we won't be immune to the impact."  
Indeed, the venerable Cincinnati-based institution already has plenty of company on that score, as packaged food mainstay Conagra Brands hiked prices by 17% an average during the quarter ended Nov. 27, a period that coincided with an 8.4% decline in sales volumes, both measured year-over-year. Similarly, peer Kraft Heinz enjoyed a 15.4% annual bump in pricing during the three months through Sept. 24, at the cost of a 3.8% drop in volumes.  
Overall, unit food and beverage sales fell by 3% nationwide last year relative to 2021, The Wall Street Journal reported Monday, citing data from tracking firm IRI NPD Group, though bountiful price increases helped push per-dollar sales higher by 10% year-over-year. 
Signs of consumer strain under the weight of those aggressive hikes are beginning to emerge.  The savings rate as a share of disposable income shriveled to 2.4% in November from 7.1% a year earlier, government-collected data show, while credit card balances showed a 15% annual advance in the third quarter, building on 12.7%, 9.2% and 4.5% respective annual increases over the preceding three such periods. Then, too, credit card outfit Discover Financial Services disclosed yesterday evening that it projects net charge offs to reach 3.9% this year, more than double the 1.82% seen across 2022 and well above the 2.8% analyst consensus. 
How might bourgeoning pushback to the bounding price increases seen of late impact the investment prospects of the (relatively, at least) red-hot consumer staples realm, which managed to finish modestly in the green during last year’s gloomy market backdrop? See the most recent edition of Grant’s Interest Rate Observer dated Jan. 13 for a newfound pick-to-not-click that may be exposed to profitability pressures and a retrenchment of its elevated valuation. 
QT Progress Report
Reserve Bank Credit edged lower by $4.3 billion, leaving the Fed’s cache of interest-bearing securities at $4.67 trillion. That’s 5.2% south of the high-water mark logged ten months ago and down $63 billion over the past four weeks, well below the $95 billion monthly target. 
Recap Jan. 19
Stocks came under moderate pressure as the S&P 500 and Nasdaq 100 each retreated by a bit less than 1%, while Treasurys provided no succor with two- and 30-year yields settling higher by seven and five basis points, respectively, at 4.41% and 3.97%. WTI crude popped back towards $81 a barrel, gold jumped to $1,934 per ounce for its best finish since April and the VIX held just north of 20. 
- Philip Grant
Slim Fast
It’s a right-sizing deluge in the Pacific Northwest.
It’s a right-sizing deluge in the Pacific Northwest. Microsoft Corp. announced plans to eliminate some 5% of corporate headcount today, with 10,000 employees set to be affected. That move, which will necessitate a $1.2 billion charge, was telegraphed hours earlier by CEO Satya Nadella in remarks at the Davos confab: “We will have to do more with less – we will have to show our own productivity gains with our own technology.” 
Microsoft’s manuver comes as fellow Seattle-based behemoth Amazon.com proceeds with its previously announced culling of roughly 18,000 staffers, the largest round of layoffs in company history. Those job cuts, initially concentrated in the Devices and Services group, are equivalent to about 6% of the firm’s global corporate staff. 
As the folks at the Kobeissi Letter relay, cumulative tech-sector layoff announcements now top 35,000 employees so far this month, while industrywide job cuts since October alone have nearly doubled the entire total during the post-bubble annus horribilis of 2001.  For context, total U.S. nonfarm payrolls stood at 153.7 million in December per the Bureau of Labor Statistics, 17% above the year-end 2001 figure. 
Stranger Things
The Bank of Japan held firm early this morning,
The Bank of Japan held firm early this morning, announcing it will maintain its negative 10 basis point benchmark overnight interest rate along with a 50-basis point cap on 10-year Japanese government bonds, a ceiling it imposes via unlimited purchases over that level. 
That stand-pat stance comes in response to recurring tests of the central bankers’ resolve, as 10-year JGB yields have repeatedly popped above that threshold during recent trading days, settling near 0.46% today following the announcement. For its part, the BoJ has shelled out some $265 billion to defend that line in the sand since Dec. 20 – when it relaxed the 10-year yield cap from a prior 0.25% -- including a record $78 billion last week alone.  For context, Japanese nominal GDP registered at roughly $4.3 trillion during 2022. 
“We do believe market functioning will improve in the future,” outgoing BoJ governor Haruhiko Kuroda, whose term is set to end this spring, declared today. “The yield curve control [program] is sufficiently sustainable.” Complicating the sustainability of his interest rate suppression regime: core consumer price inflation reached 4% in December, the hottest reading in 40 years and representing the ninth straight month north of the BoJ’s 2% annual target.  
Count some observers as less-than reassured. “Sooner or later the [BoJ] will need to tweak yield curve control again, whether under Kuroda’s reign or the next governor, but the volume of their JGB purchases remains unsustainable,” Amir Anvarzadeh, strategist at Asymmetric Advisors, writes today.  Concurring with that assessment, Citigroup’s Japan chief economist Kiichi Murashima added that “the problems with YCC are pretty explicit, so there isn’t much of a need to debate about its side-effects under a new governor.” 
Any potential capitulation to market forces by Kuroda or his yet-to-be-named successor could ripple far and wide: As Japanese investors have long ventured abroad in search of yields that don’t require a magnifying glass, higher interest rates in the Land of the Rising Sun could spur the locals to repatriate their cash.  
Japanese holdings of U.S. Treasurys top $1 trillion, equivalent to just over 4% of Uncle Sam’s public debt, while UBS reckons that Japanese investors account for upwards of 10% of France’s government bonds and nearly 20% of Australia’s sovereign market.  Indeed, Japanese institutions unloaded a net $168 billion in foreign bonds last year, preliminary data from the Ministry of Finance show, the most since at least 2005. 
Playing down the prospect of a disorderly fire sale of foreign interest-bearing securities, Brad Setser, a senior fellow at the Council on Foreign Relations, and Alex Etra, a senior macro strategist at research firm Exante Data, nevertheless concluded in a blog post yesterday that major change is afoot. “The most likely outcome in 2023 is a continuation of the roll down in Japanese holdings in foreign bonds observed in 2022. . . that more mundane reality still implies that the large flow into global fixed income from Japanese institutional investors over the last decade will dwindle to a relative trickle.”
More broadly, the end of the post-crisis, global experiment with negative nominal interest rates could usher in a perilous new epoch in worldwide finance. An analysis in the Jan. 13 edition of Grant’s Interest Rate Observer puts it this way:
It would be odd if a dozen years of misguided interest rates did not effect a correspondingly large misdirection of capital – and if a meaningful proportion of that errant investment did not wind up in the junkyard.
It would be strange, too, if a reversal of Japan’s long-running policy mix – titanic public debt formation financed by the world’s smallest interest rates – did not end with a bang.
See the editions of Grant’s Interest Rate Observer dated Jan. 13, Dec. 23, Nov.11 and Oct. 28 for more on this essential topic.  
Recap Jan. 18
Stocks took a nasty tumble after rising out of the gate, as the S&P 500 settled 1.6% in the red for the worst showing so far in the nascent year-to-date, while Treasurys caught a strong bid across the curve, highlighted by a very well-bid auction for 20-year bonds this afternoon. WTI crude slipped below $80 a barrel, gold held north of $1,900 and the VIX managed to edge above 20.  
- Philip Grant
Soap Opera
Here’s Alan Jope, CEO of consumer products behemoth Unilever, holding forth to CNBC this morning from Davos, Switzerland:
We know for sure there’s more inflationary pressure coming through in our input costs. We might be, at the moment, around peak inflation, but probably not peak prices. 
A Quiet Place
Out with the old:
Out with the old: The calendar flip into 2023 has ushered in a kinder, gentler Mr. Market, as the S&P 500 managed a near 5% rebound over the first two weeks of January to promptly erase a chunk of last year’s 18% loss.  
Yet that sterling performance out of the gate is a mixed blessing for large swaths of Wall Street. Bank of America’s latest monthly survey of fund managers finds that the proportion of respondents sporting an overweight equity allocation plunged to a net minus 39%, the lowest such figure since October 2005. That striking dynamic leaves strategists led by Michael Hartnett to conclude that “the pain trade [for stocks is] up.”
Complicating that setup: pronounced inertia in a prominent gauge of equity volatility. The CBOE VIX Index finished Friday’s trading at 18.35, its lowest reading in more than a year and well below the near 26 average level since stocks began to retreat from their bull market highs at the start of 2022. 
As Bloomberg relays today, each of the four instances last year in which the VIX finished south of 20 coincided with near-term peaks on the S&P 500, as equities promptly reversed lower in January, April, August and early December after the volatility indicator dipped into the teens. 
This Bold House
It's a crypto comeback.
It's a crypto comeback. Reports of the demise of digital assets are greatly exaggerated, as the NYSE FactSet Global Blockchain Technologies Index, which tracks shares of various industry players, has exploded higher by 49% in the young year-to-date. The ignition comes as the price of bitcoin has enjoyed an uninterrupted two-week rally, pushing the pre-eminent digital ducat back above $21,000 for the first time since FTX collapsed last fall.
That reversal of fortunes sets the stage for some industry players to mount their own revival efforts. As The Block first reported yesterday, executives at bankrupt crypto hedge fund Three Arrows Capital are seeking $25 million in seed capital to launch an exchange where creditors of insolvent digital-asset firms (including Three Arrows itself) would be able to buy and sell claims. Provisionally dubbed GTX in a cheeky nod to Sam Bankman-Fried’s former corporate plaything, the new exchange would be staffed by senior executives at Seychelles-based bourse CoinFLEX, which itself initiated restructuring proceedings in August. 
News of the newfangled trading platform attracted some less-than enthusiastic responses from various crypto luminaries: Evgeny Gaevoy, CEO of rival market maker Wintermute Trading, took to Twitter yesterday to warn would-be supporters that “if you are investing into [the] CoinFLEX/Three Arrows Capital ‘exchange’ you might find it a bit more difficult to work with Wintermute in the future (on the relationship building side).”  Nic Carter, partner at blockchain-focused Castle Island Ventures, went the sarcasm route in a tweet of his own: “Disgraced fraudsters teaming up with other disgraced fraudsters to trade claims from a collapsed fraudulent exchange. Sounds backable.” 
Other industry backers may be facing some uncomfortable questions, as the SEC is in investigating venture capital firms that took the plunge in FTX, Reuters reported earlier this month. The agency is said to be inquiring over “what diligence policies and procedures they have in place, if any, and whether [the VCs] followed them. . . at issue would be whether the firms met their fiduciary duties to their own investors.” 
Indeed, the scope of the recent digital ducat revival has its limits. As video game-focused website Kotaku relayed on Sunday, a North Hollywood domicile dubbed the “crypto house” has languished on the market since October, with the seller reducing the asking price to $949,000 from $1.2 million in recent weeks and the residence displaying a vacancy rate of 100% on its AirBnB listing (meaning its available for rental anytime). 
The four bedroom, three bath dwelling comes tastefully decorated with dogecoin and “Bored Ape” non-fungible token-themed wallpaper, along with a bedroom adorned with depictions of various bullish crypto-related tweets. As local real estate agents put it in their listing description on Zillow, the house represents an “ideal family home or income property for savvy investors.” 
Recap Jan. 17
Stocks cruised sideways in low-voltage trading to commence the holiday-shortened week, while Treasurys saw some modest steepening in similarly subdued action as the two-year yield fell four basis points to 4.18% and the long bond rose to 3.64% from 3.61% on Friday. WTI crude popped to $81 a barrel, gold retreated a bit from Friday’s nine-month highs at $1,911 per ounce and the VIX held below 20. 
- Philip Grant
Turn Down for What
The SPAC King don’t hear no bell.
The SPAC King don’t hear no bell.  As Axios first reported last fall, Chamath Palihapitiya is planning to reopen his Social Capital venture fund to outside investors, concluding a four-year stint in which the fund operated as a family office. Those fundraising efforts don’t lack for ambition, as Palihapitiya was reportedly “speaking with large investors about commitments in excess of $100 million.”
In a follow-up today, the news outlet relayed some salient details from a letter sent to prospective investors, in which the enthusiastic proponent of blank check firms during the pandemic-era boom declared that "while our early-stage portfolio continued to thrive, we were disappointed in the broader growth stages of technology investing and their interest [sic] in valuation sobriety." 
Namely, Palihapitiya will commit nearly 20% of the $1 billion target size, “likely including contributions of shares in companies backed by” a previous Social Capital fund, in which he was sole limited partner.  In other words, Palihapitiya’s personal holdings will help seed the new investment enterprise. That arrangement may prove personally lucrative, as the new fund will feature a 2% management fee (investors who commit before March will pay a discounted 1.75%), along with a 30% carry.
Tape Measure
The gauge points to “E”.
The gauge points to “E”.  As fourth quarter earnings season swings into high gear next week, Wall Street analysts now pencil in a 4.1% year-over-year decline in earnings per share across the S&P 500, FactSet vice president John Butters relayed last Friday. If that bottom-up guesstimate is on the beam, it would mark the first such annual contraction since the Covid crucible in summer 2020. For reference, the Street expected 3.5% EPS growth as of Sept. 30. 
The sell-side typically tweaks its numbers to the downside as a given quarter unfolds, but the magnitude of those post-September revisions stands out: the 6.5% aggregate decrease in S&P earnings estimates represents more than double the average 2.5% quarterly haircut over the past five years. Over that same three month stretch, analysts trimmed their full-year 2023 S&P earnings guesstimate by 4.4%, a sum that towers above the 0.2% such downside revision during the previous half decade. 
Though the bulls remain focused on easing inflationary pressures and a curtailment of the Federal Reserve’s aggressive tightening cycle (witness the S&P 500’s 10% advance since mid-October, when year-over-year CPI decelerated for a third straight reading), the prospect of a return to business as usual for corporate America would imply a more richly valued stock market then the S&P 500’s 16.5 price to forward earnings ratio might suggest. Lisa Shalett, chief investment officer at Morgan Stanley Wealth Management, relayed yesterday that, though S&P 500 operating margins contracted to 11.6% in the third quarter from the record high 13.1% achieved as the bull market peaked in late 2021, that figure remains well above the 10.2% pre-pandemic level and a 9.4% rolling 10-year average. 
What’s more, nominal revenue growth across 2022 remained 8% higher than the 10-year trend growth would imply, while personal consumption on an inflation-adjusted basis remained some 7% north of its long-run trend last year. “Considering that margins and demand levels remain so far above their historical [norms], we are likely to see performance revert to long-run average levels,” Shalett concludes. “This alone – to say nothing of a potential economic recession this year – could bring a meaningful correction in corporate results and asset prices.”
Meanwhile, a Wednesday bulletin from MarketWatch highlighted a dynamic that some investors might find alarming. To wit: the gap between reported operating earnings among S&P 500 firms and profits as measured by Uncle Sam (via the National Income and Product Accounts metric tabulated by the Bureau of Economic Analysis) has reached 25%, the largest such spread since the peak of the dot.com bubble at the turn of the century. Helping to account for that yawning chasm: the increasing prevalence of employee stock-based compensation (frequently excluded from corporate earnings data) along with slower depreciation allowances relative to government-derived calculations.
“The record divergence. . . [seen] during the year 2000 was a critical harbinger for a broader earnings recession, corporate accounting shenanigans and a nearly-three-year bear market,” Michael Darda, chief economist at MKM Partners, observed to MarketWatch.  But what’s the downside? 
QT Progress Report
A chunky $30 billion weekly roll off in Reserve Bank credit leaves the Fed’s portfolio of interest-bearing securities at $8.47 trillion. That’s down 5.1% from the high-water mark in March of 2022, and $75 billion below that seen in the second week of December. 
Recap Jan. 12
Stocks managed to edge higher in subdued trading after December CPI advanced at a 6.5% annual clip, matching the economist’s consensus, while Treasurys caught a strong bid with 2- and 30-year yields settling at 4.12% and 3.56%, respectively, down eight and 11 basis points on the session.  Key commodities also fared well, as gold closed north of $1,900 for the first time since early May and WTI crude advanced past $78 a barrel. The VIX closed below 19 for the first time since April. 
- Philip Grant
Almost Daily Grant's will resume on Tuesday
Farm to Pivot Table
Here’s Irwin Simon, CEO of global cannabis firm Tilray, Inc., laying out some tweaks to his firm’s business model during yesterday’s quarterly conference call:
The other thing is we look at facilities today, there's food shortages in the world of lettuce, tomatoes, strawberries. 
And so, we’re looking at utilization, potentially of where. . .if we have overcapacity [in the core marijuana business], how do we start growing fruits and vegetables in some of these facilities and supply food to the world where there’s major shortages and there's price opportunities there.
Tilray generated a $132 million pre-tax loss on $298 million in revenues over the six months through Nov. 30. That compares to a $30 million loss on $323 million in sales during the same period in 2021. 
One for the Optimists
An early winter thaw in credit?
An early winter thaw in credit? The calendar turn has ushered in a new state of play in the bond market, as corporate issuers have returned with a vengeance: new dollar-pay supply reached $63.7 billion during the first seven days of January, Dealogic finds. That’s nearly double the $36.6 billion seen across the final five weeks of 2022 and approaches the $73.1 billion in issuance over the first week of last year, a period which, of course, featured near-zero benchmark borrowing costs compared to the current 4.33% Fed funds rate.
An improving fundamental backdrop underpins that deal derby, as option-adjusted spreads on the ICE BofA US Corporate Index have tightened to 140 basis points over Treasury from 170 basis points three months prior, a dynamic that some believe indicates clear skies ahead. “The credit market is clearly telling the equity market, we don’t see a recession, and if we do see one, it will be a minor one,” Andy Brenner, head of international fixed income at NatAlliance Securities, told the Financial Times yesterday.  
Investors in the deep end of the credit pool are increasingly reaching that same conclusion. The iShares iBoxx High Yield Corporate Bond ETF (ticker: HYG) enjoyed a $1.7 billion net inflow last week, equivalent to nearly 10% of fund assets and the largest one-week tally since November 2020.  The cash influx comes in tandem with gangbusters price action out of the gate, as HYG logged a 2.6% rally over the first week of 2022, highlighted by a 2.75% advance for the triple-C-rated component. Triple-Cs now sport a 13.3% average yield, down from 14.26% on December 31 but nearly double the 7.2% on offer one year ago, while the Bloomberg U.S. Corporate High Yield Bond Index finished Monday at an 8.31% yield-to-worst, representing a four-month low but likewise nearly two times the early 2022 figure. 
The break towards fairer financial weather is even coaxing some new supply from the ultra-speculative cohort, as triple-C-rated energy concern W&T Offshore is marketing a $275 million, second lien secured loan to refinance an obligation maturing later this year. Triple-C-rated peer Transocean sold $525 million in senior-secured, five-year notes at an 8 3/8% coupon yesterday, with brisk demand enabling the offshore driller to both upsize the offering from a planned $500 million and price the paper below initial price talk of 9%. “’Fear of missing out’ is getting reintroduced with managers sitting on high cash balances and defensively positioned,” John McClain, high-yield portfolio manager at Brandywine Global Investment Management, told Bloomberg. “It’s off to the races now.”
How might those restless fiduciaries allocate the capital burning a hole in their pockets? See the analysis “Deep-sea fishing” in the Dec. 9 edition of Grant’s Interest Rate Observer for a bullish analysis on a natural resource mainstay toting an amply levered balance sheet, but potentially poised to enjoy a material improvement to its financial profile while arguably offering creditors a margin of safety against a downturn in relevant commodity prices. 
Widows and orphans, avert your eyes. 
Recap Jan. 10
Stocks climbed gradually higher to leave the S&P 500 with a near 1% advance as the December CPI data looms on Thursday, while Treasurys sold off in bear-steepening fashion as the long bond rose eight basis points to 3.74%.  Gold ticked to a fresh seven-month peak at $1,881 an ounce, WTI crude stayed near $75 per barrel and the VIX retreated below 21. 
- Philip Grant
Go Your Own Way
It's a scattershot dot-plot.
It’s a scattershot dot-plot. Global central banks may soon enter rarefied air, as economists surveyed by Bloomberg collectively expect that average benchmark interest rates will reach 6% in the third quarter. That compares to 5.2% currently and would represent the most elevated borrowing costs since the turn of the century. 
Yet, coming on the heels of the largest annual rise in worldwide interest rates in some 40 years, 2023 looks set to deliver a more diffuse dynamic. Among the 23 largest central banks tracked by Bloomberg, which collectively oversee 90% of global economic output, 12 are projected to continue to tighten policy, while nine are expected to cut rates and two will likely maintain the status quo. 
As the Federal Reserve prepares for its next policy rate decision on Feb. 1, Friday’s data slate provided a glimmer of hope for easy money aficionados: Average hourly earnings advanced by 4.6% year-over-year in December per the Bureau of Labor Statistics, well below the 5% consensus and the slowest such wage growth since August 2021, while November’s reading was revised to a 4.8% annual pace from 5.1%.  Coming on the heels of December’s 50 basis point funds rate increase following a series of 75 basis point moves, Friday’s data “could support another stepdown to a 25-basis point hike in February,” Rubeela Farooqi, chief U.S. economist at High Frequency Economics, wrote on Friday. 
Not everyone deemed those figures particularly revelatory, however. “It doesn’t really change my outlook at all,” Atlanta Fed President Rafael Bostic told CNBC on Friday. “I’ve been looking for the economy to continually slow from the strong position it was at in the summertime. This is just the next step in that.” Bostic relayed that his crystal ball points to a peak funds rate of 5% or 5.25% compared to the current 4.33%, adding that “we’re not going to be bouncing back and forth. We’re going to let the restrictive [stance] hold.”  Key data in the interim may help clarify matters, as December CPI is set to be released on Thursday, with economists predicting a 6.5% headline increase, which would be the coolest since October 2021. 
As Fed higher-ups maintain hawkish rhetoric in the face of potential relief on the employment cost front, peers in the Old Continent are just getting started. Staffers at the European Central Bank predicted in the ECB’s monthly bulletin today that “wage growth over the next few quarters is expected to be very strong compared with historical patterns,” penciling in a 5.2% advance in 2023, accelerating from last year’s measured 4.5% clip and a largely sub-2% growth rate going back to the end of the financial crisis.  
Today’s literary salvo comes as ECB President Christine Lagarde followed last month’s 50 basis point hike to the benchmark deposit rate by declaring that her outfit has “more ground to cover, we have longer to go,” committing to 50 basis point rate hikes in February and March. That would push the deposit rate to 3%, its highest since 2008 following an eight-year experiment with sub-zero rates. Annual inflation across the Eurozone ebbed to 10.1% in November, breaking a 16-month streak of accelerating or flat readings on a year-over-year basis. 
While central bankers on both sides of the Atlantic push ahead with their tightening campaigns despite signs of easing price pressures, one so-called emerging market mainstay forges its own path.  The Central Bank of the Republic of Turkey has responded to an acute inflationary outbreak by slashing benchmark interest rates to 9% in November from 14% four months earlier under the fastidious supervision of President Recep Erdogan, a self-described “enemy” of interest rates. 
That counterintuitive strategy may yet be paying off, as December CPI grew at a 64.3% annual rate last month, official data show, down from an 84.4% pace in November to establish a “visible downward trend” in inflation, Treasury and Finance Minister Nureddin Nebati proclaimed. Then again, the independent ENAG Inflation Research Group pegged year-over-year CPI at 137.6% in December. 
A pair of recent news bulletins color that yawning gap. Local news service Duvar reports today that a sextet of Turkish supermarket chains announced price caps for an array of staple food products, weeks after Erdogan warned that: “we will tighten the controls on market chains, we will find ways to eliminate price differences, we will monitor them.”  
That is no idle threat, considering that Erdogan showed four separate CBRT heads the door during the three years through 2021 for insufficient dovishness. Indeed, the strongman seems to have trouble turning the other cheek to economic disappointment: Bloomberg reports today that the Turkish Statistical Institute “removed a senior official overseeing the calculation of a key measure of output after worse than expected economic data.”  
The departure of Cihat Erce Isbasar from his post as chairman of the Office of National Accounts follows other sweeping changes at the agency, Bloomberg notes: “Two senior officials overseeing inflation calculations left their positions last year, while the head of the institution was removed before completing a year in office.”
Recap Jan. 9
The bulls were unable to build on Friday’s momentum thanks to a late selloff, which erased lunchtime gains of nearly 2% on the S&P 500 to leave the broad index just south of unchanged, though Treasurys remained well bid as the two-year yield followed Friday’s eye-catching rally by dropping another five basis points to 4.19%. Gold held near its recent highs at $1,876 an ounce, WTI crude rose to $75 a barrel and the VIX climbed back to 22. 
- Philip Grant
Green Tea Leaves
Never mind, Xi says.
Never mind, Xi says. China is set to pump the brakes on its lynchpin “three red lines” policy governing the country’s debt-sodden property firms, Bloomberg reports, reversing 2020-era directives that kicked off the Middle Kingdom’s slow-motion real estate meltdown.  Among the changes reportedly under consideration: permitting the developers to take on more leverage via relaxed borrowing limits, as well as granting additional time for those firms to comply with previous directives. 
That pivot comes not a moment too soon for the lynchpin real estate realm, which accounts for as much as one-third of Chinese output. Indeed, the formerly high-flying segment has endured a painful return to earth during the three red lines era, headlined by the December 2021 default of mega-developer China Evergrande Group and a 15-month streak of sequential new home price declines across 70 cities extending through November. Property investment collapsed by 20% year-over-year in November, government data show, the largest on record going back to 2000, while developers defaulted on some $50 billion of local and offshore debt last year in aggregate and face some $300 billion in principal maturities by the end of 2023.  
Yet thanks to Beijing’s newfound support (which was telegraphed by a directive from Financial Stability and Development Committee last week that regulators assist “systemically important” developers) Bloomberg’s gauge of dollar-pay, high-yield Chinese corporate bonds, which is heavily populated with property firms, rose above 75 cents for the first time in a year yesterday for a 16.63% yield-to-worst. That index sat below 50 cents with a 31.3% yield-to-worst as recently as November.   
Tellingly, perhaps, one prominent mainland observer saw fit to lob some direct criticism at President Xi Jinping’s government, after China’s ruler secured an unprecedented third five-year term at last fall’s 20th Party Congress. “Using such harsh policies toward the sector was a total mistake,” Yao Yang, dean of the National School of Development at Peking University, declared to Bloomberg. “We had companies whose business was more or less healthy, but because of the ‘three red lines,’ their business became a problem.” 
Of course, today’s about-face follows Beijing’s December reversal of its draconian zero-Covid lockdowns, weeks after throngs of protestors took to the streets across major mainland cities and workers at iPhone assembly plants rioted.  
Indicating the chaotic nature of that policy 180, The Wall Street Journal relayed Wednesday that hospital staff nationwide, as well at Chinas Center for Disease Control and Prevention, “were given no advance warning of the shift, leaving them to face a spike in patients with no stockpiles of medical essentials.” China’s economy is likewise in no rude health, as state-gathered manufacturing and service PMI data each showed their weakest readings since early 2020 in December. 
Might those abrupt policy swivels indicate larger political doings under the surface? In a Tuesday interview with Swiss financial publication The Market, co-founder of J Capital Research Anne Stevenson-Yang offered a provocative declaration regarding the Communist Party’s recent machinations: “I think there has been some kind of quiet revolt against Xi Jinping’s personal rule.” 
Noting that high-level functionaries at the mid-December China Economic Work Conference conspicuously avoided citing Xi-approved slogans like “common prosperity,” a snub which followed the President’s aggressive maneuvering at the fall Party Conference (including packing the elite Politburo Standing Committee with his own loyalists, in a break from precedent), Stevenson-Yang concluded that “that makes me believe that something very important has happened politically to reverse Xi’s power.”
The three red lines may be on their way to history’s dustbin, but the shakeout from the end of China’s debt-driven development miracle may long reverberate, our friend believes:
During the long years of the real estate boom, you had all those secondary effects. For example, because property was rising in price, local governments wanted to buy more land and develop more property. So, they bought land-use rights from people and that money in people’s pockets boosted consumer spending. Lots of new investment products saw explosive growth from the money that essentially came from real estate sales to the government. 
So that ends. That’s why you see automobile and appliance sales decline. Gambling is never going to recover, or at least never to the rates it was growing in 2012 and prior. That’s the real problem: There is too much real estate in China, and it’s overpriced. There’s not much you can do about that other than to gradually absorb the losses, which means decades of flat growth or even reversal of past gains.
Recap Jan. 6
A lighter than expected 4.6% average annual hourly wage growth reading in today’s December payrolls data ignited a scalding cross-asset rally, as the S&P 500 ripped higher by 2.3% while Treasury yields dove across the curve, highlighted by the two-yield note plummeting to 4.24% from 4.45% yesterday.  WTI crude held just below $74 a barrel, gold jumped back to near seven-month highs at $1,871 an ounce and the VIX retreated to 21. 
- Philip Grant
When I Print My Masterpiece
From Reuters:
Argentina's cash has lost so much value in recent years that local artist Sergio Guillermo Diaz finds painting on even the most valuable banknotes has become affordable. With annual inflation that likely neared 100% last year, the largest denomination of Argentine currency, the 1,000-peso bill, is worth around $5.60 officially or just $3 on parallel markets commonly used to skirt capital controls.
"Nowadays it makes sense for me to paint on the largest denominated bill here in Argentina. Once I paint on it, I can sell it for much more than what the bill is worth," Diaz said.
Shock Absorber
That's going to leave a mark.
That’s going to leave a mark. Domestic consumers are coughing up a pretty penny for their vehicles these days, as nearly 16% of those who financed a new car purchase during the fourth quarter owe monthly payments in excess of $1,000, Edmunds.com reported yesterday. That record figure compares to 10.5% over the final three months of 2021 and 6.7% in the prior year period. 
Mark Cohen, professor at Vanderbilt University, apprises Bloomberg that the $1,000 bogey represents about 17% of the monthly income of the median U.S. household, whereas the pre-2020 era typically featured auto payments equivalent to 4% to 6%. 
Compounding that painful jump in monthly outlays: the pandemic-era acceleration in pre-owned auto prices has shifted into reverse, as Manheim’s Used Vehicle Value Index slumped 15.6% over the 10 months to November to 199.4, marking the gauge’s first sub-200 reading since August of 2021 (December data are set to be released next week). As most new vehicle purchases involve a trade-in, receding used values are less than helpful for the new-model shopper. 
That downshift colors an anomaly. New vehicles broadly sold at a premium to their manufacturer’s suggested retail prices over the 14 months through October, as supply chain disruptions kept supply in check while stimulus-flush consumers were ready and willing to pay up. To wit: data from J.D. Power show that 2021 vintage auto prices rose to nearly $49,000 on average at the beginning of last year, a hefty 26% north of their April 2021 levels.  
With that dynamic now in reverse, consumers are faced with an acrid cocktail of more expensive financing and declining trade-in values. Indeed, Edmunds finds that 17.4% of new vehicle sales with a trade-in had negative equity in the fourth quarter, compared to 14.9% in the same stretch in 2021, while the average amount owed on those upside-down auto loans jumped to $5,341 over the three months through December, up 29% year-over-year. “We are only seeing the tip of the negative equity iceberg,” Ivan Drury, Edmunds' director of insights, warned yesterday. 
One industry mainstay is likewise laboring to adapt to the rapidly shifting state of play. Late last month, used auto retailer CarMax, Inc. (ticker: KMX), most recently featured as a pick-to-not-click in the Aug. 7, 2020 edition of Grant’s Interest Rate Observer, reported third quarter earnings per share of $0.24 on $6.5 billion in revenues, far below analyst expectations of $0.65 per share and $7.2 billion, respectively. Shares are now off 58% from their Nov. 2021 high water mark to leave the five-year total return at minus 10%, trailing the S&P 500’s positive 52% performance including reinvested dividends. 
By way of explanation, KMX management conveyed that “vehicle affordability issues continued to impact our. . . performance, as headwinds remain due to widespread inflationary pressures, climbing interest rates and low consumer confidence.” Sales across the retail and wholesale units fell by a combined 28% from a year ago, while wholesale gross profits collapsed by 46% over the same stretch thanks to “steep market depreciation,” the company relayed.  
How might CarMax’s peers navigate today’s suddenly harsh terrain? See “Deal us out” in the Dec. 23 edition of Grant’s Interest Rate Observer for more on the great auto market whiplash, including a new bearish analysis on an industry player potentially facing earnings pressure far beyond Wall Street’s expectation. 
QT Progress Report
A $24 billion weekly roll off in Reserve Bank Credit leaves interest bearing assets on the Fed balance sheet at $8.5 trillion.  That’s down $46 billion from the first week of December, or roughly half the central bank’s $95 billion monthly target, and 4.7% from the late-March highs.
Recap Jan. 5
Stocks came for sale with the S&P 500 losing 1.1% and the Nasdaq 100 slipping by 1.6% to erase the modest gains racked up over the past few days. Treasurys traded in haphazard fashion with two-year yields rising by nine basis points to 4.45%, while the 10-year note settled at 3.71% from 3.69% yesterday and the long bond declining by three basis points to 3.78%.  Gold retreated from multi-month highs to $1,839 an ounce, WTI crude advanced to $74 a barrel and the VIX edged above 22.
- Philip Grant
Message in a Bottle
Time flies in crypto land.  Here’s a tweet yesterday from Binance CEO Changpeng Zhao (hat tip to the @Bitfinexted account):
Don't chase high yields. I have a feeling this tweet will become relevant again in a few years’ time too. Will leave here and see.
CZ’s own marketing department may not have received the memo. Early this morning, Binance posted a tweet offering annual yields of as much as 10% on its digital currency deposits. 
Orphan Age
Private equity pulls its punches.
Private equity pulls its punches. Last year’s pronounced lurch higher in borrowing costs is ushering in a new state of play for the buyout business, as The Wall Street Journal relayed yesterday that p.e. firms are increasingly pivoting towards purchasing minority stakes in their corporate targets, with a view towards building to a controlling interest only when interest rates turn lower once more. That strategy contrasts with prior operating procedure, which typically involved financing upwards of 70% of the purchase price with debt.
“[Private equity] firms are showing flexibility so they can continue to stay in the game and do deals but not be burdened with a longstanding high interest rate on the debt,” Jonathan Melmed, co-chair of law firm King & Spalding LLP’s global p.e./M&A practice, told the Journal. Newly issued loans in the single-B and single-B-plus ratings category sported average all-in yields north of 10% in December, data firm LCD finds, more than double that seen at the end of 2021. 
That retrenchment is no minor development, considering that buyout activity accounts for roughly 60% of the supply of leveraged loans (tradable, speculative-grade, first-lien, floating-rate bank debt) by PitchBook’s lights. Indeed, domestic loan issuance slumped to just over $200 billion last year, one-third of the prior annual output and the weakest since the aftermath of the financial crisis in 2010. 
At the same time, the largest single source of loan demand is likewise in retreat. Collateralized loan obligations, the packaged and securitized collections of leveraged loans, raised $126 billion across 2022, Refinitiv finds, off 31% from the prior year’s record haul. December’s $3 billion in issuance was by far the lowest single month of the year.
A further waning may be in the cards in 2023, thanks to a broad-based weakening in corporate credit in the face of rising interest rates and a potential earnings slowdown. Leveraged loan downgrades outpaced upgrades in the third quarter at a 2:1 clip, S&P Global finds, up from 1:1 over the prior three months and representing the worst such ratio since the pandemic. Similarly, November represented the heaviest single month for leveraged loan downgrades since May 2020. 
That dynamic could cause problems in CLO land, as managers are typically limited to a maximum 7.5% portfolio weighting for triple-C-rated credits, on pain of dividend payout constraints and unfavorable mark-to-market rules for those exceeding that cap. Triple-C-rated loans account for a 5.6% of CLO assets on average, analysts at Bank of America found last month, though some 20% of CLOs have exceeded their 7.5% limit, double the share seen in October. 
“We’re not talking about breaching the 7.5% threshold by just a little bit,” Steve Caprio, head of European and U.S. credit strategy at Deutsche Bank, tells the Financial Times today. “We’re talking about triple-Cs potentially going as high as 12% to 15% [of CLO portfolios] in a worst-case scenario.”  Attempting to avoid that outcome, managers will likely curtail purchases of the single-B and single-B-minus rated variety, as those loans are most at risk of downgrade into CCC status, though “that in and of itself. . . will actually cause some issues within the loan market,” Caprio believes. The single-B-minus category accounts for a hefty 30% of CLO portfolios, S&P Global finds, the highest tally on record. 
Sure enough, the suddenly rugged funding conditions and reluctance of CLO managers to add risky credits has manifested into a pronounced “haves vs. have-nots” dynamic. A December analysis from JPMorgan Chase identified a bulging bifurcation in the loan realm, as the share of issues trading at 96 cents on the dollar or better jumped to 55% of the $1.4 trillion total from 23% at the end of June, while, over that same stretch, the population of loans fetching fewer than 80 cents on the dollar (a threshold associated with distress) likewise grew to 5.2% from 2.4%. “There’s a universe of loans everyone is chasing and another one that no one is buying,” Roberta Goss, head of the bank loan and CLO division at Pretium Partners, told Bloomberg. 
Recap Jan. 4
Stocks managed to settle moderately higher in a choppy trading session, as the S&P 500 gained just under 1% following yesterday’s flat showing. Treasurys likewise caught a bid as the 10-year yield dropped to 3.69% from 3.79% a day ago, while WTI crude retreated 5% to $73 a barrel and gold advanced to $1,861 per ounce, its best finish since mid-June.  
- Philip Grant
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