Frasers increases Hugo Boss stake to €900mn
Sports Direct owner buys nearly 5% of stock in German fashion brand
Frasers Group has raised its stake in Hugo Boss to about €900mn in the latest move by the UK retailer to boost its exposure to the German fashion brand.
The UK-listed retail company, known for its Sports Direct and House of Fraser brands, said on Wednesday that it had bought stock representing 4.9 per cent of Hugo Boss’s total share capital.
The company, founded by Mike Ashley, has also upped its stake through the sale of put options, amounting to 26 per cent of the German company.
The latest investment increases Fraser’s maximum exposure to approximately €900mn.
Frasers said the “strategic” move reflected its “belief in the Hugo Boss brand, strategy and management team”.
It comes after the retailer initiated a £35mn share buyback on Monday, under chief executive Michael Murray who succeeded Ashley last month.
Frasers last increased its stake in Hugo Boss in April, when it bought shares worth 2.1 per cent of Hugo Boss and sold put options representing 23.2 per cent of the German company’s total share capital.
Supercar makers start to go electric
Tighter emission rules and evolving client demands force producers towards battery powered vehicles
For many years, Luciano Colosio’s garage was governed by an iron rule: all cars must have 12 cylinders.
A McLaren F1, a $2.6mn Pagani, a Bugatti Veyron, two Aston Martin One-77s with hand-built Cosworth engines and, of course, a steady parade of Ferraris, all passed through his collection. Not any more.
At the age of 61, the former landscape engineer has paid a deposit of €380,000 on a €1.98mn Pininfarina Battista, a fully electric model that promises to usher in an era of silent supercars. Only 150 Battistas will be produced. The design — with sweeping lines reminiscent of the elegant style of Pininfarina’s Italian heritage — appealed, but so too did the battery technology that powers the wheels.
“I had a chance to see this car in person,” he recalls, by video call from his office in Zurich. “I thought, this is a car that could be good for me, we are in a real problem in the world and it could be time to change.”
Colosio made his wealth running a series of businesses, from real estate to pharmaceuticals. “All the other cars, they are,” he says, pausing to think of the right word in English, “stinky, and they make a lot of noise”. For years, the “stink” and the noise were two of the visceral appeals of supercars, along with the exclusivity guaranteed by prices that start at $200,000.
Ferrari, Lamborghini, Aston Martin and McLaren, the industry’s stalwarts, have also been singularly slow to shift away from the powerful, hungry engines that are the soul of their vehicles. Around 22,000 vehicles classed as supercars or luxury GTs were sold last year, an 18 per cent increase on a year earlier, according to figures from Jato Dynamics. Not one was fully electric.
While the performance benefits of electric power have long been integrated into the top hybrid supercars, from the LaFerrari to the McLaren P1, no manufacturer has yet put a petrol engine-free version into its line-up. But, just as Tesla, and a host of start-ups from Nio to Rivian, are using electric technology to break into the mass market, so there are new players in the market for supercar batteries, as well.
Chief among them is Rimac, a Croatian business founded by Mate Rimac that makes its own cars and also supplies electric technology to other manufacturers, including the hybrid-engine systems in Aston Martin’s Valkyrie hypercar. Rimac has only made eight Concept_One models; its second car, the Nevera, sells for about €2mn and begins deliveries this summer.
Last year, Porsche took a controlling stake in the business in a deal that will see Rimac run the luxury Bugatti brand in the future. SoftBank also recently invested. Automobili Pininfarina, the other major new entrant, uses Rimac’s driving systems for the Battista, its first electric model that, after delays, is expected to ship later this year. But it plans to use its own technology in future models.
Despite the great promise of blistering acceleration that is offered by battery technology, maintaining the driving experience of traditional supercars with fully electric power is a challenge. The established industry believes that today’s battery technology remains unsuited to supercars that need to be equally adept skimming around a racetrack as they are traversing continents on an epic road trip. At the same time, lightweighting — the key to a sports car’s agility — is made even more complicated given that the batteries weigh several hundred kilos.
But, despite these challenges, the tightening emissions rules for new cars and changing customer demands are combining to force today’s supercar names, willingly or otherwise, down the electric avenue.
“However irrelevant in the grand scheme of climate change, supercar makers need to decarbonise their vehicles and neutralise their total carbon footprint, if only to maintain social acceptance,” writes Philippe Houchois, an auto analyst at Jefferies, in a research note about the sector.
The cost of batteries, which holds back the rest of the electric car market, can hardly be a problem at the upper end, believes Julia Poliscanova, a director at the green policy group Transport & Environment. “Supercars tend to have super margins and premium customers, so going electric faster than the mass market EVs is do-able,” she says. “There’s also an equity argument: why should the super-rich who buy them be allowed to emit while the rest of the society has to reduce emissions?”
Ken Choo, who runs HR Owen, the world’s largest Ferrari and Lamborghini dealer, says that his customers are indeed asking about electric vehicles, even if only out of curiosity, or a desire to be seen doing the right thing. “They want to be the first in one, it’s more fashionable to be in a clean electric car,” he says.
Rimac, as the first brand to market, has a head start over others but also faces the challenge of ploughing the virgin snow. “There are no other electric hypercars on the market, so there is no reference point for customers,” explains Mate Rimac. The company will have no problem selling out of its models, he predicts, “but we need to do events and get lots of people behind the wheels”.
If would-be buyers prefer to stay with brands they know, then they will have to be patient. One by one, the mainstream names are only tentatively rolling out electric plans.
Ferrari will release its first fully electric car in 2025, and 40 per cent of models will be battery-only by the end of the decade, while Volkswagen’s Lamborghini marque has promised a fully electric model “this decade”. McLaren will this year release its latest hybrid, the Artura, but will not have a fully electric model until 2028. The group, based in south-east England, is held back, in part, by the fact it has few close links with a larger manufacturer.
Aston Martin, an English carmaker that has long relied on shareholder Mercedes-Benz for its systems, aims to release an electric car in 2025, with its entire line-up hybrid or electric by 2026. “We’re moving at the pace our customer wants us to,” says executive chair Lawrence Stroll. “In all fairness, I can’t tell you 100 per cent of Aston Martin customers want an electric vehicle today.”
“No offence to Tesla, but it’s not the same people who buy an Aston Martin. We still have people who want the smell and the noise, and we are gradually on the way to getting to EV, but we will continue offering both.”
While the rest of the auto industry is setting dates for ending production of internal combustion engines — Mercedes in 2030 if possible, Stellantis by 2038 — makers of top-tier racers remain tight-lipped about the longevity of their powerhouse technology. “We will still continue to offer [petrol cars] for sale, as long as there is consumer demand,” says Stroll, even though the petrol models will feature some hybrid technology from the middle of the decade.
In fact, for dealerships, fears over the end of the petrol engine are even prompting an unexpected boom. “It’s actually helping the sale of the engine cars, because it’s the last batch before it turns electric,” says Choo at HR Owen. “People are trying to enjoy the engine as much as possible because they know it’s running to an end.”
Analysts question whether supercars even need to go electric, as they travel far fewer miles than the “daily driver” cars used for everyday transport.
The carbon impact of manufacturing batteries, which is normally offset during an electric vehicle’s emissions-free driving life, will take longer to counteract with models that travel such short distances.
“What looks like a late start may turn out to be wise given the overall limited environmental impact of supercars driving a few miles”, writes Houchois at Jefferies, “and the accelerating pace of technology progress in batteries and electrification”.
“Considering how few supercars are on the road and how little they drive, enforcing emissions policy may have more to do with political and social considerations than actual greenhouse gases.”
Despite pioneering electric cars, Mate Rimac goes further. “Europe is shooting itself a little bit in the foot, killing this industry in the future in my opinion, if all the [emissions] rules are applied to the supercar industry as well,” he says. “The environmental impact of these cars is so small, they are so small in number and they are hardly driven. You are basically selling pieces of art, and Europe is a world leader.”
Meanwhile, the owners, many of whom run their own businesses, believe lowering emissions through their companies makes more of an overall impact than changing a car that they drive rarely, if ever.
Graham Royle, 62, has seven cars, including three Ferraris, two Lamborghinis, the McLaren Senna hypercar and a Range Rover. All, bar his LaFerrari hypercar, are under two years old. “Other than my Range Rover as a daily driver, my petrolhead cars spend little time on the road, so I do not feel they threaten the environment with major concerns of adding to global warming,” he says.
Running two large businesses under the umbrella of GRI Group — one manufacturing consumer products and own-brand shower gels, the other in chemicals — gives him more opportunity to lower overall emissions, he believes. “My companies are actively engaged in using sustainable, natural raw materials, developing ultra-efficient manufacturing technologies, and creating products which have much less impact downstream on the environment,” he says. “We are working to very aggressive carbon footprint reduction targets. We have set targets to be carbon neutral by 2026 and net zero by 2030.”
Three years ago, Royle, who lives near Sheffield, prepared to make the jump, placing his name on the waiting list for a Pininfarina Battista. But delays to the car, changes at the fledgling manufacturer, and rising concerns over the overall carbon impact of EVs gnawed away at his commitment until he cancelled the booking.
“EV technology has developed rapidly over the last few years — car manufacturers can now make high performance EVs for £50,000-£150,000 — so why spend £2mn on an EV hypercar?” he asks. “During the last two years, I decided to stick with being a petrolhead, until we can see a quantum leap in pure EV technology.”
Winning over customers such as Royle will be key to Ferrari and Lamborghini taking their current, fiercely loyal, driver base along with them on their electric journey. “You will not capture everyone, there are petrolheads that have gasoline in their veins, and they will not change,” says Pininfarina boss Per Svantesson.
Nevertheless, the brand’s experience of offering test drives of its EVs has won round some converts. He recalls one at the Pebble Beach Concours d’Elegance, a car fair in California, with a Bugatti owner who believed his ground-shaking 16-cylinder model was the pinnacle of driving. “He was sceptical,” says Svantesson. “But, after the drive, he said ‘I thought I had the ultimate car, but I need one of these’.”
Roughly a third of Pininfarina’s customers are “converts” from petrol, another third are Pininfarina collectors with vintage Ferraris designed by the group, while the rest are completely new to the supercar world. In fact, Rimac’s first ever customer, Paul Runge, is just such a newcomer.
A month after running into Elon Musk, then the little known chief executive of Tesla, at the Detroit auto show in 2014, Runge was leafing through a magazine when a feature caught his eye. The article was a profile of the young Croatian entrepreneur Mate Rimac and his electric supercar company. Though he had never been “a car guy”, the ophthalmologist took a deep interest in battery-powered vehicles, and had already upgraded his Toyota Prius hybrid to a fully electric Nissan Leaf.
Intrigued, Runge emailed the company. Weeks later, he was on a plane to Zagreb to see the company and meet its founder. A video of his first experience in the car, with Rimac at the wheel, features the deep red car spinning, tyres squealing as smoke wafts up from the asphalt of the company’s empty car park.
“I was smitten,” recalls Runge, who is now 75. Immediately, he placed a €50,000 deposit for one of the eight “Concept_One” cars that Rimac planned to build. The payments would eventually grow to €750,000 — less than other early buyers who paid €1.2mn, because Runge invested in the business — as well as more than a dozen flights from his home in Florida.
These semi-frequent trips were more than just progress reports. The company was new and growing, and Runge would often drive the latest iteration, with Mate Rimac himself in the passenger seat taking notes on a laptop. “It’s like Steve Jobs sitting in the passenger seat asking what I would like different on my computer,” says Runge excitedly.
Runge is, by his own admittance, not a traditional auto enthusiast. He once test-drove a McLaren at a Los Angeles dealership, and remembers it vividly. After a few minutes, the dealer told him to floor the accelerator. More than a decade later, he recalls the visceral sensation. “It was, wow, I could almost feel it getting out of control,” he says, but he decided the head-turning petrol machine was “not me”.
Whether because of the driving experience or the social stigma, it is likely that more and more buyers will decide the supercars of old are “not them”. Add to that the rise of new, eco-conscious, wealthy classes in China and elsewhere, plus advances in technology and reformed petrolheads, and there is likely to be no shortage of interest in the vehicles.
Pininfarina’s Svantesson calls the advent of electric supercars “guilt-free luxury”.
He adds: “We offer a hope to the world that you can continue to enjoy things, even in a sustainable way.”
>>> Up
* Admicom Raised to Buy at Inderes; PT 63 euros
* Ceres Power Raised to Buy at Goldman; PT 700 pence
* Elkem Raised to Neutral at Citi; PT 35 kroner
* NatWest Raised to Buy at Jefferies; PT 359 pence
* Orange Raised to Equal-Weight at Barclays; PT 10.50 euros (+)
* Smurfit Kappa Raised to Buy at Jefferies; PT 3,700 pence
* Telia Raised to Overweight at Barclays; PT 50 kronor (+)
>>> Down
* ArcelorMittal Cut to Neutral at JPMorgan; PT 32.50 euros
* Carrefour Cut to Underperform at Bernstein; PT 16.50 euros
* flatexDEGIRO PT Cut to 16 euros from 30 euros at Oddo BHF (+)
* Grifols Cut to Neutral at Alantra Equities; PT 20.39 euros
* Grifols ADRs Cut to Neutral at Alantra Equities; PT $21.44
* Kone Cut to Hold at Berenberg; PT 50 euros
* Kone Cut to Sell at Goldman; PT 44 euros
* Mips Cut to Hold at Berenberg; PT 600 kronor
* Stendorren Fastigheter Cut to Hold at Handelsbanken
* Verkkokauppa.com Cut to Hold at Nordea
* Vodafone Cut to Equal-Weight at Barclays; PT 140 pence (+)
* Voestalpine Cut to Underweight at JPMorgan; PT 27.50 euros
>>> Initiation
* Believe Rated New Neutral at Oddo BHF; PT 11.50 euros
* Sartorius Stedim Biotech Rated New Buy at HSBC; PT 410 euros
* Stora Enso Re-Initiated Buy at Handelsbanken
* Zordix Rated New Buy at Pareto Securities; PT 35 kronor
>>> Call
* Carrefour Cut at Bernstein on Price War, Reduced Chance of M&A
* Elkem Loses Last Sell Rating as Citi Cites Rising Silicon Prices
* JD Sports Results Are In Line With Market Expectations: RBC (+)
* Mips Cut to Hold at Berenberg on Lack of Near-Term Triggers
* NatWest Upgraded to Buy at Jefferies on More Obvious Upside
* Structural Growth Shines Among Industrials When IP Growth Erodes
* Umicore Capex Guidance Makes Outside Financing Likely: Jefferies (+)
* Wentworth On Track For Another Record Year, Peel Hunt Says (+)
* Zur Rose is New Underperform at CS on ‘Difficult Transition’ (+)
Miracle technologies will not be the answer to aviation’s net zero emissions pledge
Perhaps the world needs to learn that flying is not a human right
Willie Walsh probably meant to deliver an upbeat message to aviation executives in Doha this week for the annual meeting of the International Air Transport Association. In fact, IATA’s director-general may have unwittingly sent a nervous shiver through the room when he said that air traffic could “exceed pre-pandemic levels” next year.
Having made the commitment in October to achieve net zero emissions by 2050, the industry is quietly panicking about how to reach that target. While carriers will be delighted with the recovery, how much harder will it be to get to net zero if demand is rising far faster than expected?
The aviation industry also has a record of overpromising. A recent report by climate charity Possible found that airlines and aviation bodies have met only one of 50 climate targets in 20 years. Why should this time be any different?
Some leading airline executives are already casting doubt on the target. Akbar Al Baker, chief executive of Qatar Airways, said in Doha this week that it would be “very challenging”. Tony Douglas, chief executive of Etihad, has suggested that some executives have signed up to the 2050 goal knowing they would be gone when the target was missed.
To be fair, the aviation industry is not in control of its own destiny. To get to net zero, airlines need vast amounts of sustainable aviation fuel (SAF). Energy companies are producing less than 0.1 per cent of aviation’s needs. But even that will not be enough, as SAF is at best 80 per cent more carbon efficient than normal jet fuel — and only over its lifetime. It still emits carbon when burnt.
So the industry has pinned its hopes on technological miracles to take it to net zero.
Iata’s own net zero pledge depends on a 13 per cent emissions reduction from new propulsion technologies, including aircraft powered by green hydrogen. Produced by the electrolysis of water, this does not emit CO₂ when burnt as a fuel.
The UK government-backed FlyZero study concluded that to meet net zero commitments, hydrogen-powered, midsized jets carrying close to 300 passengers would have to be in service by 2035, with zero-emitting narrow-bodies flying by 2037. Moreover, 50 per cent of the global commercial fleet would have to be hydrogen powered by 2050. It also added that six revolutionary technology breakthroughs would be required to get those aircraft flying. That is a big ask in any scenario.
Privately, industry executives are very sceptical. Substantial obstacles remain to storing hydrogen on aircraft, and the ranges they can fly will be far shorter. And let’s not forget the lengthy process of safety certification. Then, trillions will have to be invested in a wholesale revamp of aircraft design, fleets and infrastructure. “The 2035 deadline is not realistic,” a well known aviation executive told me. At best, use of hydrogen will be incremental by 2050.
It is not just about the technology. Martin Lambert, senior research fellow and head of hydrogen research at the Oxford Institute for Energy Studies, estimates green hydrogen — which requires vast quantities of renewable energy to manufacture — accounts for just 0.1 per cent of global energy consumption today. Meeting Europe’s overall target for 20mn tonnes of green hydrogen in 2030 would require double the amount of renewable energy the bloc produced in 2019, he said.
Last week DNV, a technical adviser to the oil and gas industry, estimated hydrogen will only account for 5 per cent of global energy demand by 2050. It is open to debate whether aviation will be the first port of call for this green hydrogen. The first in the queue are likely to be those industries that already use the grey version — produced from fossil fuels — such as the fertiliser sector or refineries. After that, vital basic industries such as food production or steel would arguably take priority.
Green hydrogen will be a scarce commodity. Instead of spending billions on subsidising hydrogen aircraft development, governments would do better to incentivise the expansion of sustainable fuels. These could be used by existing aircraft, making an immediate impact on aviation emissions.
Even delivering enough SAF will not get aviation to net zero. Ultimately, the only way to guarantee that aviation will not emit is to not fly, or to make flying so expensive that people make far fewer trips. Perhaps the world needs to learn that flying is not a human right. It is a choice and some choices are more costly than others.
The big risk to equities now is earnings, not valuations
Investors have probably seen only the first phase of this bear market in stocks
As global equities go deeper into bear market territory, it is important to recognise the unusual nature of this sell-off.
The pain so far has come largely from a contraction on the valuation placed on the more expensive stocks and their earnings prospects. This means we have probably only seen the first phase of this bear market.
With valuations having come down so far, the greatest risk to equities now comes from actual earnings falling short of current expectations. The next leg of the bear market is likely to be driven by earnings recessions, especially in the more cyclical stocks, sectors, and markets.
So far, the compression of valuations — measured by the ratios of price to trailing earnings for global stocks — has been the greatest since the stagflation of 1975.
Despite all the recent gloom hanging over markets, stock analysts’ forecasts point to uninterrupted gains in global, US and even eurozone earnings for this year, 2023 and 2024.
This continued confidence contrasts with all the talk of recession as the US Federal Reserve tightens monetary policy, raising rates. And it comes in the face of a sharp slowing of activity indicators, a collapse in chief executive confidence, the start of a moderation in pricing power and a strong US dollar which increases costs for non-American companies.
The current data signal a synchronised slowdown around the world. Rather than uninterrupted earnings per share growth, our models point to an earnings recession in the year ahead. We expect US earnings to fall by an 10 to 15 per cent over that time.
Perhaps even more impressive is that the consensus EPS forecast for the Euro Stoxx index companies is signalling increasing earnings expectations despite the war in Ukraine and a cost of living crisis that is likely to raise costs and reduce demand for corporates. Our “top-down” forecasts suggest that eurozone EPS could fall by an annualised 20 per cent in the year ahead.
Any earnings recession will have its largest impact on cyclical sectors such as industrials, tech hardware and energy. Currently, energy is forecast to post the strongest earnings growth of any of the main industry groups, both in the US and globally. However, nearly every global earnings recession has seen energy earnings growth in negative territory.
This means that for our earnings recession call to be correct, we will probably need to see oil sector earnings slow sharply.
Currently, however, the energy sector EPS forecasts for the year ahead are the strongest of any of the main industry groups. It may be that supply constraints and the Ukraine war may make things “different this time”.
However, if we look at the official US forecasts for oil inventories from the US Energy Information Administration and take into account the fact that economic recession will depress oil demand, our models point to double digit falls in oil EPS growth in the year ahead.
That energy analysts are reliant on a “this time is different” mindset is evident in EPS forecasts for value and growth stocks.
Value stocks tend to come from the more cyclical sectors in the economy, such as energy, industry and finance. In the past, such sectors have shown greater earnings volatility.
In this economic cycle, value stocks are expected to see continuous EPS gains over the next two years, while earnings expectations for growth equities have already begun to moderate.
The irony is that analysts have been much more willing to cut their forecasts for growth stocks. This is despite the fact that, historically, they are the ones that have tended to deliver more stable EPS growth. If activity slows, rate rises come to a halt and bond yields start to stabilise or come down, then these growth stocks will have already more realistic EPS forecasts and may be well placed to rally relative to value “plays”.
There is little doubt we are in unusual, volatile times for investors. But the rationale of “this time is different” to explain stock market conditions has been a recurring warning sign for investors, cycle after cycle. If central banks succeed in reining in the current surge in inflation by damping demand, earnings should follow suit. That means more pain for equity investors.
UK officials weigh national security grounds to force London IPO for Arm
Plan has drawn criticism within government circles and tensions with SoftBank over lobbying effort
The UK government has debated the use of national security legislation as a means to convince SoftBank to list Arm in London, as the Japanese investor reconsiders holding an IPO for the chip designer exclusively in the US.
Two people familiar with internal government discussions said it had weighed applying the UK’s new National Security and Investment Act, but has not formally done so. Some government officials have pushed back against the idea of invoking the law, believing it would not be applicable as the proposed listing was not considered an acquisition.
Government officials said they had preferred attempts at persuasion. Lord Gerry Grimstone, Britain’s investment minister, has met with Rajeev Misra, head of SoftBank’s $100bn Vision Fund, according to people briefed on the efforts, while Prime Minister Boris Johnson sent a letter to SoftBank executives.
A person involved in the discussions said the UK government had so far used “carrots” rather than “sticks” in the talks and had offered to provide Arm subsidies on research and grants. This person added that officials have not made specific threats and that their message was more akin to “you don’t want to make an enemy out of us”.
The interventions reveal how retaining Arm’s image as a UK success story has become a hot political issue, amid criticism that British markets are no longer an attractive home for globally significant tech companies.
Before SoftBank’s purchase in 2016 for $32bn, Arm was dual listed, with its primary stock held on the London Stock Exchange and secondary stock held via American Depositary Receipts in New York.
Representatives of the Japanese investment group have held a series of talks with UK ministers and officials in recent weeks, after SoftBank’s founder Masayoshi Son announced plans to return Cambridge-based Arm to the public markets.
The intense lobbying has led SoftBank to reopen the door to a listing in London to complement a principal listing in the US, according to multiple people familiar with the situation.
A spokesperson for the culture department said Chris Philp, technology minister, had not raised national security concerns with SoftBank. Both SoftBank and the UK’s business department also denied Lord Grimstone had raised the NSIA with the Japanese company.
But a person familiar with ongoing talks said SoftBank executives became aware of the UK government’s discussions about potentially using the NSIA in future, considering it a ploy to push Arm towards a London listing.
This aggravated some of SoftBank’s leadership, the person said, as the move made little business sense because the US market is by far the most liquid and is where most prospective investors are based.
Another person who has worked with the government on the law said while the decision to launch an IPO would not itself be enough to allow the business secretary to intervene, if a foreign company took a significant stake in Arm following the listing, that could trigger a notification to the government. At that stage, the UK could attempt to block that stake or ask for it to be unwound.
People close to discussions said the listing venue does not have to be picked for several months and no final decisions have been reached.
A dual IPO, which would raise dollars and sterling, would be a modest win for UK officials, who fear a further weakening of the British tech sector and knock-on effects for banks, analysts and advisers.
The NSIA gives the secretary of state the power to call in transactions they “reasonably suspect give rise to or may give rise to a risk to national security”, according to a business department (BEIS) document.
If deemed “necessary and proportionate”, the minister is then able to “impose certain conditions, block or unwind it completely”.
The UK government has so far “called in” 17 transactions. The first to be made public was an examination of the takeover last year of Newport Wafer Fab, in Wales, by Nexperia, a Dutch subsidiary of Chinese company Wingtech, and the second was French telecoms group Altice’s majority stake in the telecoms group BT.
Arm lies at the heart of the global tech industry. Its chip design IP is licensed to semiconductor companies and electronic manufacturers around the world and used in more than 90 per cent of smartphones.
A successful listing at a targeted valuation of at least $50bn is critical to SoftBank, whose Vision Fund last month posted a historic investment loss of Y3.5tn ($26bn) after its portfolio companies were hammered by regulatory crackdown in China and a global sell-off in technology shares.
European debt: risk before reward
‘Anti-fragmentation’ is risky, expensive and worth a shot
Europe’s debt mess
Clearly, we should have written about the European debt proto-crisis last week, but we were too captivated by the Fed to catch up on the situation properly.
While we dithered, the European Central Bank seems to have scared sellers of European peripheral bonds into backing off, buying some time to come up with a structural solution to this problem:
That’s the spread between Italian and German 10-year bonds, which began widening as soon as it became clear that inflation would force the ECB to follow the Fed in raising interest rates. At the right side, you can see how the ECB’s emergency meeting last Wednesday, and the promises of action issued afterwards, reversed the widening, for now.
Recall the basic problem. Italy — which is emblematic of many peripheral eurozone countries from Spain to Greece — has even more debt than it did when it slipped into a crisis 10 years ago. The maths is really nasty now. Italy’s debt is 150 per cent of gross domestic product. Its 10-year bonds, for example, yield 3.7 per cent. Of course it will have sold debt at lower yields than that, but as old debt rolls over, the cost will rise. GDP, on the other hand, is not going to grow at anywhere near 5.5 per cent (3.7 per cent x 150 per cent). So the Italian debt burden is set to grow steadily bigger relative to GDP.
This causes problems. Higher interest rates slow growth in general. Households own quite a lot of the debt, creating negative wealth effects. Banks own a lot too, so as the bonds lose value, their balance sheets weaken and they can’t make as many loans. Then there is the possibility of portfolio contagion bringing other European asset prices down. The debt wobbles could also push the euro even lower, and therefore push the dollar even higher — which is an automatic tightener of financial conditions globally.
This is all quite bad. And then there is the very remote but not unthinkable political follow-on: life within the eurozone becomes so unpleasant for Italians that the country decides to leave the common currency.
The ECB really does not want any of this stuff to happen. Hence its commitment to some kind of bond-buying programme, or “anti-fragmentation instrument”, that would compress Italian (or other peripheral) debt spreads. The details will come next month.
The good news is that the ECB governing council seems to be on the same page, and they are getting after the problem early. As rapid and unsettling as the rise in spreads has been, their absolute level was higher as recently as 2018-19, as the bank’s bond-buying programmes tailed off. Same chart, going further back:
The bad news is that the job of depressing the spreads is made complicated by inflation. It is bonkers to buy bonds and raise rates at the same time. In monetary policy terms, the two have opposite effects. So the ECB plan will have to involve some form of “sterilisation” to keep the peripheral purchases neutral to the money supply. Presumably this will mean sales of some other flavour of euro bond, or some sort of term deposit mechanism to sop up the proceeds from the bond purchases (it may also be that anti-fragmentation means that the ECB will have to enact more rate increases than it would have otherwise).
This is all a big experiment. As Eric Lonergan of M&G summed up in Monday’s FT:
Sovereign spread targeting by a central bank has never been done before. The outline of a programme would involve creating a reference basket of “safe” European sovereign bonds from core eurozone countries such as Germany and determining an acceptable spread for each market. The ECB would then commit to enforcing a cap on these spreads . . .
We need to be clear about the risks. In extremis, the ECB becomes the market-maker for [Italian] or other bonds. Liquidity could disappear. How will Italy issue debt in the primary market, and at what price? Can the arrangements be gamed by market participants? How will the ECB exit?
The ECB is in terra incognita, and if things go wrong, the world economy is going to receive yet another nasty growth shock.
How much money will the ECB spend buying peripheral bonds, and will it be enough? Frederik Ducrozet of Pictet has estimated that €10bn a month could be put to work initially, raised by redemptions of assets bought under the Pandemic Emergency Purchase Programme. But, he points out, twice that amount of Italian debt needs to be rolled over through the rest of this year. Pepp reinvestment “probably falls short of the support needed in case of severe fragmentation and protracted market dislocations”. The ECB may have to go further.
So this could get expensive. But there is the possibility of a significant long-term upside. The original sin of the eurozone is common currency and monetary policy without a central fiscal policy, like the one enjoyed by the US. Anti-fragmentation could be a step in that direction. Here is George Saravelos of Deutsche Bank:
The [proposed anti-fragmentation] tool increases implicit fiscal pooling and establishes a de facto eurobond. A peripheral backstop can theoretically be conceived as a put option on [Italian bonds] and a call option on [German] Bunds thereby creating a more stable GDP-weighted risk-free rate. Assuming the operations are sterilised, the eurosystem will absorb peripheral risk on its balance sheet in exchange for short-dated risk-free liabilities (most likely term deposits) thereby increasing fiscal pooling. An investable [European bond] basket improves European yield. Consider that the Euro-US 10-year interest rate differential is at an eight-year high outside of Covid.
Europe has proven in the past that, under duress, it will do what it takes to hold together its fragile and faulted monetary-financial-political structure. If it does so again this time, it might also end up making some structural improvement.
Given this, it might be tempting to try the Jon Corzine memorial trade, and bet that spreads will compress before you get margin called. Not a stupid bet but, as Corzine discovered, a tricky one to time.
IEA warns Europe to prepare for total shutdown of Russian gas exports
Agency chief says governments should keep ageing nuclear plants open and take other contingency measures
The International Energy Agency has warned that Europe must prepare immediately for the complete severance of Russian gas exports this winter, urging governments to take measures to cut demand and keep ageing nuclear power stations open.
Fatih Birol, the head of the IEA, said Russia’s decision to reduce gas supplies to European countries in the past week may be a precursor to further cuts as Moscow looks to gain “leverage” during its war with Ukraine.
“Europe should be ready in case Russian gas is completely cut off,” Birol told the Financial Times in an interview.
“The nearer we are coming to winter, the more we understand Russia’s intentions,” he said. “I believe the cuts are geared towards avoiding Europe filling storage, and increasing Russia’s leverage in the winter months.”
The IEA, which is primarily funded by members of the OECD, was last year one of the first official bodies to accuse Russia publicly of manipulating gas supplies to Europe in the build-up to the invasion of Ukraine.
Birol said emergency measures taken by European countries this week to reduce gas demand, such as firing up old coal-fired power stations, were justified by the scale of the crisis despite concerns about rising carbon emissions.
He said the increase in coal-fired generation was “temporary” and would help preserve gas supplies for heating in winter. Any additional CO₂ emissions from burning highly polluting coal would be offset by an acceleration in Europe’s plans to cut its reliance on imported fossil fuels and to build up renewable generation capacity, he added.
But he warned that the steps taken by European governments so far probably did not go far enough if Russian exports were completely severed, and said countries should do everything possible to preserve supplies now to ensure storage could be filled ahead of the winter months.
“I believe there will be more and deeper demand measures [taken by governments in Europe] as winter approaches,” Birol said, adding that rationing of gas supplies remained a real possibility should Russia cut exports further.
Sweden and Denmark on Tuesday followed Germany, Austria and the Netherlands in announcing the first stage of emergency plans to preserve gas supplies, but none of those national plans yet include rationing.
Europe has reduced its reliance on Russian gas to about 20 per cent of total supplies since the Ukraine invasion, from around 40 per cent before, according to consultancy ICIS, but has already tapped most options to diversify supplies, such as seaborne cargoes of liquefied natural gas.
The IEA chief said countries should try to delay shutting down any nuclear power facilities earmarked for closure to help limit the amount of gas burned in electricity generation.
Germany has faced sustained criticism for its decision to continue decommissioning the last of its nuclear plants during the energy crisis.
While Birol did not single out any country he said all “should consider postponing closures [of nuclear power plants] as long as the safety conditions are there”.
Berlin has indicated it believes the technical and safety hurdles to keeping the plants open are too high.
Birol was speaking ahead of the publication of a new IEA investment report on Wednesday, which warns governments are not yet doing enough to encourage investment in renewable energy to curb fossil fuel demand. Total energy investments are expected to grow this year by 8 per cent to $2.4tn, with the growth coming from renewables and higher costs.
Last year the IEA said the world did not need to invest in new oil and gasfields if governments were to hit their net zero targets by 2050.
Birol said that without enacting policies to significantly cut fossil fuel consumption the world would continue to face dangerous swings in oil and gas prices. “Unless governments sit in the driving seat and mobilise major funds to create a clean energy transition,” he said, “we will have to deal with extreme volatility in energy.”
While there were some positive signs of growing investment in cleaner forms of energy, partly stemming from Europe’s desire to break its addiction to Russian energy, he said globally the picture was at best mixed.
In the developing world, excluding China, renewable energy investment has not grown in real terms since 2015. Birol also said developing countries reliant on fossil fuel production needed to use the windfall from higher prices to diversify their economies.
“The relative weakness of clean energy investment across much of the developing world is one of the most worrying trends,” the IEA report said.