The golden age of arbitrage has begun
The law of one price is in retreat — with major consequences for profits, inflation and innovation
In the Strait of Hormuz, tankers have been burning, along with what remains of the post-1945 American-led order. Meanwhile, the IMF’s new baseline forecast for global growth this year is exactly the same as it was six months ago and stock prices have gone up. The contrast between a world order on fire and a world economy on autopilot is glaring. Some argue that geopolitical crises only have transitory economic effects. Yet if you look closer, strange and profound changes are under way.
A prime example is the law of one price. It holds that similar products that are tradeable across borders should have similar prices. After 1990, free trade, supply chains and new global rules on intellectual property reinforced the power of this law. The idea of a unitary market for fungible products, in which the nationality of the buyers and sellers didn’t matter, went from a fantasy to a day-to-day reality. Superstar firms built business models to exploit this, which is one reason why iPhones and Bloomberg terminals cost roughly the same everywhere.
Now the law of one price is in retreat. A less reliable America means more wars and crises that disrupt trade. Sanctions and economic nationalism create barriers, making markets less fungible. You can see the alarming results in commodities. The recent prices of nearly identical barrels of oil traded in Texas, Guyana, the North Sea and Russia ranged between $97 and $147, some of the biggest gaps ever recorded. Last year the price of gold, the ultimate fungible asset, divorced in Europe and New York. Copper, silver and nickel have seen similar dislocations.
But it goes beyond commodities. Some Chinese product prices are violently out of whack with American ones as the economies decouple. In tech the gaps can be huge. AI tokens, units of data processing, cost about 80 per cent less in China than in California, while Nvidia B200 chips cost about 50 per cent more. Because China-US trade in cars is minuscule, electric vehicles in Dalian cost at least 30 per cent less than their equivalents in Detroit. There is more to come. China’s biotech boom is unleashing cheap breakthrough drugs.
Some of these exceptions to the law of one price will prove transient. But the trend is not. In the cold war, political crises over Cuba or Berlin had little economic relevance. Today, globalisation means that about 50 per cent of all trade and capital flows pass through places or sea lanes with high military tensions, from the Baltic Sea to Taiwan.
That means there is widespread exposure to low-probability but severe events. Meanwhile the global embrace of industrial policy is just getting started, suggesting more barriers to open markets are coming. Politicians are more likely to try to protect firms they have subsidised from foreign low-cost competition.
There are three implications. First, a golden age of arbitrage is under way as traders who exploit disparities, for their own profit or for clients’, thrive. Thanks to volatility and price gaps, JPMorgan’s markets arm has just booked the best result in its history. Energy and metals traders are making a killing.
Business models dismissed as relics are relevant again. Japan’s trading houses, often created in the 19th century, are on a tear. A rush of macro-hedge funds, which bet on geopolitical events and disparities, are opening, 14 years after their patron saint George Soros quit and they were written off as obsolete. There are experiments in digital arbitrage, with so-called neocloud firms renting out remote access to AI chips to users in different countries, without too many questions asked.
Arbitrageurs’ profits can be thought of as a tax that the world pays to incentivise firms to try to bridge fractured markets. The numbers are getting big: commodity firms and Wall Street trading desks are making $140bn a year, double the level in 2019.
Second, there will be consequences for inflation. During the 1990s and 2000s, inflation was low and converging across the world. But if the erosion of the law of one price becomes widespread and sustained, overall inflation rates could diverge more. Already in the past five years, US consumer prices have risen by a cumulative 25 per cent, versus 51 per cent in Russia and a mere 4 per cent in China. Big differences in inflation will eventually feed through into bigger gaps in interest rates and exchange rates. Places with higher prices could ultimately have weaker currencies and lower asset valuations.
Finally, the age of arbitrage could catalyse innovation. Entrepreneurs have a major incentive to invent products that bypass trade barriers and geopolitical flashpoints. The 20th century’s Middle East oil crises led to new deepwater drilling techniques in the North Sea, pipelines in Alaska and larger, faster oil tankers. A new wave of geopolitical innovation could now be upon us.
Breakthroughs in energy and materials science could cut the reliance on products imported through chokepoints. Manufacturing automation could lower the need to rely on factories abroad. AI agents could get ever better at masking users’ nationality, running rings around the digital barriers governments erect. All this is hard to imagine today. The law of one price seemed like second nature. But there is another law: the world always adapts.
Investors push for higher yield on $14bn of Oracle-backed data centre debt
Huge bond offering comes amid concerns over Oracle’s debt load and the recent flood of AI-related issuance
Investors are demanding a higher-than-usual premium to back a $14bn bond offering by an Oracle-backed data centre project, amid growing concerns over the huge amounts of AI-related debt coming on to the market.
The sale, which has been privately pitched to a small group of institutions in recent weeks, is to fund a 1 gigawatt data centre in Saline Township, Michigan, as part of a $300bn agreement with OpenAI to provide the ChatGPT maker with 4.5GW of computing power, say people familiar with the matter.
However, some investors have questioned whether Oracle — whose aggressive AI spending plans have been a source of market worry in recent months — could provide sufficient guarantees to ensure debt repayment if the project were delayed or if Oracle ever exited the lease backing the project bond. The tech giant is only a tenant, rather than a joint owner of the facility.
To compensate for these risks, some investors had demanded yields of more than one percentage point over Oracle’s publicly traded corporate bonds due in 2040, the people said, and more credit protections, including the removal of a proposed option that would allow the issuer to buy back the debt early. Few, however, expect this ultimately to scupper the deal as the order book is still well covered.
“It’s still project finance ultimately,” one of the people said. “You’re still going to take construction risks.”
Big Tech companies have borrowed more than $100bn in global bond markets so far this year to help fund the AI arms race, fuelling investor concerns that the runaway capital expenditure might not translate into actual profits and may be a bubble that could hit the broader economy.
The Oracle-backed data centre is being built by developer Related Digital, and the debt is being issued by a special purpose vehicle. Investors say that raising debt off Oracle’s balance sheet helps alleviate their concerns over the rising debt load at the company, which raised $25bn from the bond market in February after it pledged to preserve its investment-grade credit rating.
However, if the deal went ahead, it it could open up a new wave of financing for similar project-level bonds without equity stakes from big tech companies, said Gianluca Bacchiocchi, a partner at Clifford Chance specialising in financing energy and infrastructure projects.
The sale was being led by Bank of America and was expected to launch in the so-called 144A market in the coming weeks, allowing thousands of institutional investors to trade the bond, the people said, adding that final pricing and terms were still subject to negotiation.
Some investors who had been approached privately were hoping to secure the debt early on and resell a portion of it for a quick profit when the deal launched to the wider group of investors, the people said.
“This is a new asset class that only emerged in recent months. There is no quant model for us to calculate what is a good relative value for a deal,” said Katie DeSplinter, head of US credit trading at Capital Group, speaking about such deals in general.
Pimco was expected to be an anchor investor of the bond sale, while Blackstone would provide about $2bn of equity in addition to the debt, the people added.
Blue Owl Capital also considered backing the project but did not proceed as negotiations stalled, the FT previously reported.
Bank of America, Related Digital, Blackstone and Pimco declined to comment. Oracle did not respond to requests for comment.
Unlike traditional project loans that need to be refinanced within four to six years, a project bond can provide financing with longer maturities to minimise refinancing risks.
While banks used to provide the bulk of financing for data centre build-outs, large-scale projects are increasingly turning to other types of debt investors as the massive deal sizes overwhelmed the bank market.
“There’s more caution among banks,” said Bacchiocchi. “Some are reviewing whether they need to reduce or hedge some of their positions.”