TheChek News Flow

Has US inflation peaked?

US inflation is expected to have moderated in May, in a sign that inflation may have peaked, as weakening consumer demand and loosening supply chains mitigate price growth.

In April, the US consumer price index moderated for the first time in eight months to an annual pace of 8.3 per cent, 0.2 percentage points lower than the previous month. Despite the modest decline, inflation came in above economists’ expectations and remained at a 40-year high.

Still, a second consecutive moderation in the annual rate should offer “hope that we have indeed passed the peak in inflation”, said James Knightley, chief international economist at ING.

May’s consumer price index data, due to be published on Friday, may, in turn, give further clues as to how aggressively the Federal Reserve will raise interest rates in June and thereafter.

Economists polled by Reuters expect monthly consumer prices to have risen 0.7 per cent in May. Consumer price growth slowed to 0.3 per cent month on month in April, as surging energy and food costs fuelled by the war in Ukraine abated.

Housing, food and energy are likely to continue to contribute to inflation, as petrol prices rose in May, but that could be partially offset by auto prices and a loosening supply chain.

“Auto prices could be one of the softer CPI components because consumers are unwilling to pay current prices, so demand destruction is bringing supply and demand into balance,” said Steven Englander, a strategist at Standard Chartered.

There have been reports of increases in inventories and imports and recent rises in auto production, which could be evidence of some improvement in supply chains, Knightley said. “But order backlogs remain long and supply chains remain vulnerable to Covid containment measures elsewhere in the world.” Alexandra White

With inflation setting new eurozone records every month so far this year, it will be hard for the European Central Bank to explain why it is not immediately raising interest rates when its policymakers meet in Amsterdam next week.

Yet this is exactly what ECB president Christine Lagarde is likely to do on Thursday when she is expected to say that the central bank is sticking to its pre-announced plan to first stop buying more bonds before starting to raise its deposit rate from minus 0.5 per cent.

That means the earliest the ECB could raise rates for the first time since 2011 is at its subsequent meeting on July 21, after it stops adding to its €4.9tn bond portfolio.

The main question left to be resolved is how big the July rate rise will be. The ECB’s chief economist, Philip Lane, said this week that quarter percentage point rises were its “benchmark pace”. But he left the door open for others to “make the case for moving more strongly”.

Klaas Knot, president of the Dutch central bank, and Robert Holzmann, Austria’s central bank chief, have both discussed the potential for the ECB to follow in the footsteps of the US Federal Reserve with a half percentage point rate rise. A majority of investors polled by Deutsche Bank in May thought this would happen.

Andrew Kenningham, an economist at Capital Economics, predicted that “core inflation will continue to surprise on the upside and this will ultimately prompt the ECB to move more rapidly than many now anticipate” by ending its eight-year experiment with negative rates with one bumper rise in July. Martin Arnold

China’s economy was buffeted by strict and widespread coronavirus lockdowns in April, with several indicators plummeting to two-year lows. While the severity of restrictions largely stabilised in May — and even showed signs of tentative easing towards the end of the month — the limited respite was likely not enough to avert a further slew of weak data.

Both manufacturing and services purchasing managers’ indices came in several points higher in May but remained in contraction territory, meaning that while the rate of decline in activity slowed, most companies still engaged in less activity than they did the month before. Caixin’s China manufacturing PMI also noted that the time taken for orders to reach manufacturers had increased “markedly” in May, suggesting that the country’s logistical problems were far from over.

Other indicators will probably show similarly muted improvements: analysts at Citi predict that retail sales, which declined by 11.1 per cent year on year in April, will contract by a lesser 6.8 per cent in May. Likewise, while the analysts predict trade will recover slightly, April’s data suggest the days of booming Covid-era exports are well over.

While Beijing on Wednesday instructed policy banks to extend an Rmb800bn ($120bn) credit line to fund infrastructure spending, overall stimulus is much weaker than in 2020.

A question remains over whether the slight easing in restrictions that helped cushion China’s economy last month will be sustained as the country vows to stick to its zero-Covid approach, with economists worried about the possible damage from another round of widespread lockdowns.

“Shanghai’s phased-in reopening may only represent a respite rather than a turning point,” Ting Lu, analyst at Nomura, wrote in a note. “The real turning point will be marked by a shift in China’s stance on its ZCS [zero-Covid stance] rather than headline Covid caseloads, the easing of some lockdowns or monthly activity data.” William Langley

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Crypto’s Wild West Days May Be Coming to an End With New Bipartisan Senate Bill

Barron’s has obtained a draft of the bill, which contains substantial changes from a widely circulated version that we reported on in May.

A few things stand out in the revised bill, co-authored by Senators Cynthia Lummis (R., Wyo.) and Kirsten Gillibrand (D., N.Y.).

For one, it would split oversight of the industry, granting the Commodity Futures Trading Commission primary authority over the crypto spot markets, while leaving the Securities and Exchange Commission with oversight of a broad swath of tokens.

The latest draft also scales back a provision that would have allowed for a new crypto self-regulatory organization.

The bill would also broaden the definition of tokens that would be policed by the SEC as compared to the old draft. Provisions would give the SEC authority to regulate some types of digital tokens, including those that derive profit from others’ managerial efforts or that provide a financial interest in the token’s issuing entity.

The latest version also allows courts to make exceptions to the presumption that a token counts as a commodity. The earlier version had given that power to both the courts and the SEC.

Lummis and Gillibrand have said they plan to release the final bill next Tuesday.

“The bill clarifies the universe of digital tokens that would fall under the SEC’s jurisdiction,” said a spokesperson for Lummis. The latest draft “restricts the SEC’s authority instead of expanding it,” the spokesperson added.

“There have been multiple drafts circulating recently,” said a spokesperson for Gillibrand. “This is not the final draft and further changes are still being made.”

The earlier version of the bill had attracted sharp criticism from part of the industry. Some lobbyists viewed it as creating an unwieldy regulatory regime, carving up oversight among the SEC, CFTC, and a new self-regulatory organization. They also said that version gave the SEC too much leeway in determining that a token qualified as a security.

The more recent version includes significant changes, some of which seem to be in response to industry feedback. It is unfinished and will likely change further before the bill is released, according to people familiar with the matter.

Rather than authorizing a new regulatory body, for instance, the 67-page draft would ask the SEC, CFTC and industry groups to analyze the creation of such an organization. While some crypto organizations and companies had supported the creation of a self-regulatory body, the Blockchain Association, an industry trade group, had opposed it.

Other provisions of the new draft include:

• Excluding up to $100 in income from capital gains tax if a cryptocurrency is used to buy goods or services. The earlier draft had previously set the limit at $600.
• Creating a process for companies to register as a “digital asset exchange”
• Establishing an “advisory committee on financial innovation” that includes members from the SEC, CFTC, Federal Reserve Board, the fintech industry, consumer protection groups, and others. The committee would study various aspects of the crypto industry and make regulatory and legislative recommendations to the White House and Congress.
• Requiring studies on energy use in digital asset markets and on DeFi protocols, and new standards on the use of China’s central-bank digital currency on government devices

With less than six months until the midterm elections in November, it is unlikely that the Lummis-Gillibrand bill, or any comprehensive legislation on crypto, will pass Congress this year.

Still, the industry has closely watched this bill’s development. If nothing else, it sets the stage for debate and potentially passing something in next year’s Congress.

Lummis and Gillibrand recently noted that their bill would have to clear four Senate committees, but Gillibrand said she expected votes in the Senate next year “at the latest.”

Increased volatility delivers windfall for investors betting on debt and currency moves

High levels of inflation and supply chain bottlenecks have created the best conditions for hedge funds trading bonds and currency markets since the 2008 financial crisis, according to one of the pioneers of macro investing.

Kenneth Tropin, who founded $17bn-in-assets Graham Capital in 1994 and was previously chief executive of billionaire John Henry’s investment firm, is among the big-name macro managers reaping rewards as central banks rapidly raise interest rates to combat surging inflation.

“I can’t recall a more interesting time to be a macro investor since the financial crisis. We’re finding a lot of opportunities,” said Tropin, who is also Connecticut-based Graham’s chair, in an interview with the Financial Times.

“Inflation was so low for so long that central banks underestimated the potential for that genie to get out of the bottle and for how far it could go,” he said. “It’s pretty easy to see that global central bank policy has gone from being a headwind to a tailwind for macro.”

Tropin also highlighted the war in Ukraine and supply chain issues that could take “a very long time” to fix as factors adding to market volatility.

Macro trading, made famous by the likes of George Soros and Louis Bacon, involves betting on global bonds, currencies and commodities and tends to prosper when there are large moves in such markets. However, many funds struggled for years to make money as central bank stimulus suppressed the volatility in interest rates and other markets that they like to trade.

The onset of the coronavirus pandemic proved a major opportunity for them to profit. As central banks raced to loosen monetary policy, funds placed bets that bond prices would jump. Some, such as Andrew Law’s Caxton Associates, made record gains.

Last year proved more difficult for some, as markets began to fret that interest rates would have to rise much faster than central banks had indicated. Chris Rokos’s Rokos Capital and New York-based Alphadyne were among those badly hit as policy-sensitive short-term government debt plummeted.

This year, however, funds have been better prepared to play a large sell-off in bond markets, particularly in longer-dated paper — a price move they have been anticipating for years. They have also been able to profit from betting on one bond against another.

Graham’s Proprietary Matrix fund is up 23.8 per cent this year, while its Absolute Return fund has gained 14.3 per cent.

Among other funds benefiting is Brevan Howard, one of the best-known names in the sector. The hedge fund has been bearish on government bonds and focused much of its trading on medium-term maturities in the market, said one person familiar with its positioning.

Brevan’s $9bn Master fund has gained roughly 13 per cent this year.

Rokos, a former co-founder of Brevan, has risen 12.5 per cent this year at his Rokos Capital, helped by bets on rising bond yields. Meanwhile, Crispin Odey’s Odey European fund has gained about 87 per cent, helped by aggressive bets against longer-dated bonds.

Tropin said that while he did not think inflation will move much higher from current levels, investors were underestimating how long it would take for inflation to fall back to the US Federal Reserve’s target level.

“Some of the pressures that have moved inflation higher are not about to subside,” he said. “It could be two-and-a-half or three years” before it falls back into line.

Tropin added that, after large moves in markets this year, his funds were positioned more cautiously for now. But he remains optimistic for the trading opportunities ahead.

“I like the odds that the market will continue to be volatile and to have big ranges,” he said. “On a three- to five-year cycle is it going to be really good for macro? I do think so.”

Dispersion of stock performance has created opportunities for profit

Hedge funds are having to adapt to a radically different market environment this year. For some, life has become much tougher. But for others, these are precisely the conditions they have long been waiting for.

A new world of high inflation, sharply rising interest rates and rapid quantitative tightening, almost unimaginable just a few years ago, has upended equity and bond markets over the past six months. Eurozone inflation this week hit another record high of 8.1 per cent, increasing pressure on the European Central Bank to speed up rate increases.

High-growth technology stocks have been particularly hard hit. While they can soar to enormous valuations when interest rates are near zero, higher rates mean their prospective future profits look relatively less attractive. Tiger Global and some of the other “Tiger cub” hedge funds that prospered during the bull market have felt the full force of this sell-off, in some cases losing much more than the wider market.

But for some managers who focus on exploiting price discrepancies between stocks, conditions are now in their favour. They had been left frustrated by the “everything rally” in which investors often appeared unconcerned about whether they were buying a high- or low-quality company. However, the removal of the ultra-low-cost financing that was long available to companies is starting to separate the wheat from the chaff.

“Market neutral [equity] and low net funds should benefit from stocks . . . reflecting fundamentals now,” said Kier Boley, chief investment officer of alternative investment solutions at UBP, referring to funds that try to make money from weighing one stock against another, rather than predominantly from betting on rising prices.

A perfect example of how conditions have changed for such funds is London-based Sandbar Asset Management. A year ago, I wrote in this column that the firm with $2.2bn in assets, founded by former Millennium trader Michael Cowley, was struggling with the seemingly illogical way in which markets were operating.

For instance, the correlation between an improvement in expectations about a company’s earnings and the reaction in its share price, which intuitively should be positive, had fallen “to levels not seen in the last decade”, Sandbar said at the time. In some sectors such as aerospace, it had even turned negative, meaning improving earnings expectations would actually push a share price lower. Sandbar ended the year down 7.5 per cent.

Much has changed since then. The fund is up 6.7 per cent in the first four months of this year, compared with a 7.3 per cent fall in equity hedge funds on average, according to data group HFR, and a 14.5 per cent drop in the S&P 500 index as of Wednesday.

Significantly, so-called alpha — industry jargon for the money a manager makes from their skill rather than simply from following overall market moves — has been positive for the fund for each of the past four months.

A major reason, according to Sandbar, is the fact that markets have now entered the “latter stages of the economic cycle”. It wrote in a letter to investors that this has historically represented a time when conditions have been most supportive for funds like itself. This was because “dispersion [between stocks] increases significantly” while returns from simply following the market moderate or turn negative.

The unwinding of positions by other investors at the end of last year and early this year as the market fell created opportunities for Sandbar to profit in recent months, it added.

While the outlook for such managers has improved markedly, there are still factors that could yet hinder their progress. Stocks have rallied over the past couple of weeks on hopes that bad news on the economy will persuade central bankers to limit interest rate rises. And, as UBP’s Boley points out, even if a manager gets the analysis of a stock’s fundamentals correct, their positions can still be knocked off course by a major investor unwinding its book.

Nevertheless, this sifting of the industry, which has long been forecast but often delayed by years of central bank stimulus, is being welcomed by many.

Hedge funds have struggled for much of the past decade to justify why investors should pay their high fees when returns were often uninspiring compared with index-tracking funds — available at a fraction of the cost — or compared with the profits apparently on offer from private equity funds.

In a world in which returns from stocks and bonds are now less appealing, hedge funds that do not simply try to ride the markets but instead exploit market dislocations may finally have hit their stride.

Other routes out can deliver only a fraction of total grain stockpile, says minister

Ukraine has warned that the world faces a critical food shortage unless Russia lifts its Black Sea port blockade, as improvements to other transport options would only enable it to deliver a fraction of its total grain stockpile.

Oleksandr Kubrakov, Ukraine’s infrastructure minister, told the Financial Times that “all of our activity won’t cover even 20 per cent of what we could do through the Black Sea ports”.

Ukraine and its western allies are searching for ways to get up to 20mn tonnes of grain out of the country and clear storage space for this year’s harvest. The crisis threatens tens of millions of people in countries across the Middle East and Africa that rely on Ukraine’s cereals.

Trucks face lengthy delays at the border with Poland and Romania, while moving grain by rail is difficult because trains in the EU and Ukraine run on different gauges of track. Russia has repeatedly bombed the alternative routes, including those leading to Romania by road or rail, where grain is then loaded on barges that sail down the Danube and into the Black Sea.

The EU has simplified its procedures and Ukraine is offering additional guarantees to European barges and trucks after most western insurers shied away because of the risk.

Despite those efforts, Kubrakov said it would prove insufficient. “Everyone is doing superhuman activity, and the [amount exported] is growing every month . . . in the short term it could go up to 30 per cent [of Ukraine’s Black Sea exporting capacity],” he said.

Russia has captured much of Ukraine’s breadbasket in the south and is making progress in the eastern Donbas industrial region, the scene of the fiercest fighting three months into Putin’s invasion of Ukraine.

Since late February, Russia has seized between 400,000 and 500,000 tonnes of grain from occupied territories. Some Ukrainian farms have been hit by air strikes and artillery fire.

President Vladimir Putin has blamed the food crisis on sanctions against Russian exports and said Moscow would only lift the blockade if the restrictions were lifted. On Friday, he said in a state television interview: “The problem of exporting grain from Ukraine does not exist.”

Kubrakov warned that Russia’s actions risked creating famine “on a global scale” and Moscow was acting like “total pirates”.

“They don’t care about the lives of these people in Africa,” he said. “They’re telling them: ‘We don’t care about you. We are only worried about sanctions against us. Now you are hostages.’”

Kubrakov said converting a single railway line to the EU standard would cost $2bn-$3bn, with more investments needed to expand capacity at border crossings.

Kyiv has discussed sending up to 4mn tonnes of grain a month via Belarus, which uses the same railway gauges, and on to a port in Lithuania, according to a government briefing document seen by the FT. But the plan is politically unpalatable because Belarusian leader Alexander Lukashenko let Russia use his country as a staging post for its invasion of Ukraine.

Though export capacity via the new routes is rising, EU diplomats estimate that Ukraine can only export about 5mn tonnes of grain by the end of the summer, leaving the rest of the last harvest at risk of rotting and making it more difficult to store this year’s.

“There is no quick solution, unfortunately,” Kubrakov said. Expanding storage capacity would also mean investing billions of dollars in grain silos along the new routes, he added.

The risk to Ukraine’s cereal crops has awakened traumatic memories of the country’s man-made famine of the 1930s when it was part of the Soviet Union. Peasants had their grain taken from them and were confined to their villages, leading to the deaths of 4mn people in what is known as the Holodomor, or death by starvation.

Kubrakov said the consequences of the Black Sea blockade could be even worse. “They did the Holodomor in our country once, yes? Now they have the chance to do a Holodomor on a global scale,” he said.

UN secretary-general António Guterres is leading an effort to unblock the Black Sea ports and secure guarantees from Russia not to attack commercial shipping.

Russian foreign minister Sergei Lavrov said this week that Putin and Turkish president Recep Tayyip Erdoğan had agreed to help de-mine Ukrainian ports, which Kyiv has blocked to guard against a coastal assault.

But Ukraine says Russia has fired on several cargo vessels and mined the sea route blocking their safe passage through the Black Sea, making any potential agreement contingent on third-party guarantees for the ships’ safety.

Kubrakov said the negotiations were Russia’s “last chance to avoid essentially being guilty for the deaths of millions of people on several continents”.