Potential Peloton (NASDAQ: PTON) killer iFIT was due to IPO this week but opted to postpone due to adverse market conditions. The stock markets are in flux just now as an accumulation of factors impact investor confidence. These include inflation concerns, higher energy costs, and Chinese company defaults.
iFIT says it will continue to evaluate the timing for its proposed offering.
Who is iFIT?
The owner of top health and fitness brands NordicTrack, ProForm, Sweat, Freemotion, Weider, Weslo, and 29029 has gone from strength to strength in recent years, and investors are excited to see if it can give Peloton a run for its money.
iFIT is a global fitness and well-being company manufacturing its own hardware and enjoying recurring revenue from a digital subscription model. The company has an impressive legacy dating back to 1977.
iFITs suite of recognizable brands are powered by its iFIT integrated health and fitness platform. In turn, this seamlessly connects its software, content, and interactive hardware.
While iFIT products and subscription technology are not cheap, it is primarily considered an affordable alternative to Peloton.
iFIT ups its game
While iFIT has been around for decades, it was trundling along inconspicuously until Peloton arrived on the scene. As Peloton’s star rose, the iFIT founders took note and agreed it was time to up their game.
Earlier this year, an example of this occurred when an extensive film crew took to far-flung locations to build a series of virtual workouts in inspirational settings. Locations include Mount Everest, Maui, the Grand Canyon, Mount Kilimanjaro, and the Swiss Alps.
At home, iFIT participants can participate in these virtual workouts on their touchscreen-enabled treadmills, bikes, rowers, and ellipticals. The equipment is geared to adjust to the terrain automatically.
Its subscription packages include an individual membership for $15 a month and a family package for $39 a month.
In its S-1 filing the company states:
We believe we are the only provider delivering a seamless solution of software, content and hardware with offerings across treadmills, bikes, ellipticals, rowers, climbers, strength equipment, fitness mirrors, yoga equipment, and accessories in the global market. We have a growing international presence with distribution in over 120 countries.
Soaring revenues, mounting losses
iFIT revenue has been climbing:
- 2019: $699m
- 2020: $851m
- 2021: $1.7bn
But, so have its losses:
- 2019: $56m profit
- 2020: -$98m loss
- 2021: -$516m loss
Thankfully, its subscription revenue is on the rise:
- 2019: $73m
- 2020: $123m
- 2021: $229m
In its S-1 filing iFIT also states:
We believe the breadth of our equipment range across modalities, brands, price points and distribution channels gives us the largest SAM (serviceable available market) among our primary competitors in the fitness industry.
Billionaire businessman Bernard Arnault invested $200m in iFIT last year via private equity firm L Catterton. This deal gave iFIT a $7bn valuation.
When iFIT IPO’s, it’s expected to aim for a valuation of $6.7bn.
Its most recent financial results included distribution sales of 44% direct-to-consumer, 2% strategic partners, and 54% wholesale.
Competition is mounting in the health, fitness, and wellness space. Indeed, Peloton is not the only competitor iFIT has to contend with. There are many private and publicly-listed companies vying for consumer attention from all corners of the globe.
- Peloton has a market cap of $26bn.
- Apple (NASDAQ: AAPL) is growing its fitness subscription revenues.
- Nautilus (NYSE: NLS) has a $298m market cap.
- Johnson Health Tech (TPE: 1736 ), listed in Taiwan, has a $500m market cap.
- Anta Sports (HKG: 2020) is a Chinese fitness firm with a $45bn market cap.
- Technogym (BIT: TGYM) is an Italian health company with a $2.3bn market cap.
And there are several more competitors to watch:
AI-powered fitness mirror startup Tempo which tailors programs to individual needs. Its built-in AI personal trainer gives the impression of being in the room with you. Tempo last raised $220m in a Series C funding round in April 2021.
Spin bike studio SoulCycle plans to launch its own at-home bike in October. Back in April, SoulCycle’s parent company Equinox Holdings, was rumored to be in talks with Chamath Palihapitiya to go public via SPAC. Those plans appear to have ended.
Tonal is another AI-powered health and fitness company that makes strength training machines. According to Crunchbase, Tonal has raised a total of $450M in funding over 6 rounds. Their latest funding was raised on Mar 31, 2021, from a Series E round.
Coveted yoga-wear brand Lululemon Athletica (NASDAQ: LULU) bought fitness device maker Mirror for $500m in June 2020.
American fitness and media company Beachbody Company (NYSE: BODY) went public via SPAC earlier this year. During its IPO it also merged with exercise bike maker Myx Fitness.
Is iFIT a good investment?
When a company launches at IPO there is often an initial bounce, followed by a dip in its share price. This means buying in at IPO is not always the most strategic move.
iFIT shows great potential in its growing revenues and subscription numbers but it faces considerable competition. With the world reopening there is a concern that the workout-at-home theme which dominated 2020 may be less prevalent going forward.
Nevertheless, iFIT is a well-established company with a suite of impressive brands and a management team dedicated to staying ahead of the curve.
Mandating ESG disclosures really makes a difference
Here is the first in a series of regular articles on current academic research into a range of sustainable investment topics. The papers discussed were…
Here is the first in a series of regular articles on current academic
research into a range of sustainable investment topics. The papers discussed
were presented at the latest annual GRASFI conference.
The Global Research
Alliance for Sustainable Finance and Investment is a collaboration of
universities committed to producing high-quality interdisciplinary research and
teaching curricula on sustainable finance and investment. In this series, we
highlight compelling papers presented at the latest GRASFI conference, with a
comment from a ‘practitioner’ at BNP Paribas Asset Management.
As the sustainable investor for a changing world, BNP Paribas Asset Management sponsors
GRASFI’s efforts to bring academic rigour to the challenges of sustainable
finance and investment. Through its sponsorship, BNPP AM is able to access
leading academic research into sustainable finance and investment,
helping to inform the broader debate. Our goal is to share these reflections
with clients and the industry. Visit the GRASFI Conference website.
The conference’s winning paper – The effects of mandatory ESG disclosure
around the world
As the dangers of environmental, social and governance (ESG)
risks have been broadly explored and acknowledged, many countries have imposed
mandatory rules on companies to report more information on these issues in
their financial disclosures or standalone sustainability reports.
One driving factor is the need to improve the supply of
information by companies to investors and other stakeholders, whose demands for
more disclosure on ESG risks have grown both
considerably and rapidly. However, has mandatory ESG disclosure really made any
‘The Effects of
Mandatory ESG Disclosure around the World’, the research paper rated the
best submission and awarded the BNPP AM sponsored Best Paper Prize, found that
mandatory disclosure of ESG information improves the level of reporting and has
numerous informational and real effects, while the average quality of ESG
reports stays roughly the same.
The analysis by Philipp Krueger, Zacharias Sautner, Dragon
Yongjun Tang and Rui Zhong is based on an international dataset of mandatory
ESG disclosure regulations between 2000 and 2017 that were introduced in 25
countries including Australia, China, and the UK.
The research also looked at how mandatory ESG disclosure
affects the information set that key market participants use when evaluating
Mandatory ESG reporting – More, but not necessarily better
According to the study, the percentage of companies that
file ESG reports in the Global Reporting Initiative (GRI) database, which
allows investors to easily access and bulk-download ESG reports, increases by
56% after ESG disclosure is made mandatory.
However, the authors found that, on average, such regulation
has no effect on the quality of ESG disclosure reports. They measured this by
checking if the reports adhered to the GRI’s
While they could not find a strong reason to explain why
this was the case, they noted that firms with lower ESG reporting quality made
significant improvements after ESG disclosure was required.
The level of reporting depends on several factors. Mandatory
disclosure will have a bigger effect on smaller firms as they are less likely
than their larger peers to have voluntarily disclosed ESG information before.
The authors found that smaller firms – as well as those with lower ESG quality
– are more likely to file ESG reports after mandatory disclosure is introduced.
Conversely, larger firms – as well as those smaller
companies with better ESG policies – may have already voluntarily disclosed ESG
information before the introduction of rules. This is also the case for
international firms. This may be because they have stronger motives to disclose
on ESG to a wider audience and are more exposed to stakeholder scrutiny.
Benefits for market participants
Even if mandatory disclosure increases the availability of
ESG reports, does it improve the information used by financial market
participants to value firms?
The author’s findings indicate that ESG disclosure
regulation is beneficial.
Mandatory ESG disclosure has positive informational effects
on market participants because it increases “the availability and quality of
firm-specific non-financial information”, thereby improving the information
used to forecast earnings, the report said. Also, the mandatory nature of the
disclosures “could reduce ambiguity about the fundamentals of a firm.”
The authors said the accuracy of earnings per share
forecasts by financial analysts improves significantly after disclosure becomes
mandatory, and forecasts become less dispersed.
Fewer ESG disasters
Meanwhile, negative ESG incidents, such as the 2010 spill in
the Gulf of Mexico, become less likely after ESG disclosure is introduced. The
researchers measured such incidents using a proxy constructed by RepRisk
based on media reporting about negative ESG events.
A reduction in negative ESG events can lower the risk of
stock price crashes, according to the report. Indeed, after mandatory ESG
disclosure is introduced, the likelihood of stock price crashes decreases by
about 26%, the authors found.
The significance of these events falls after mandatory
disclosure because news about them is transmitted faster to markets. “When
accumulated bad ESG news reaches a tipping point and [is] released to the
market all at once, such batch-releases can result in sharp stock price
declines,” said the authors.
Since mandatory disclosure regulations accelerates ESG
information disclosure through ESG reports, crash risk may decline after
The authors conclude that mandatory ESG disclosure
regulation improves the corporate information environment and lead to real
Given the numerous benefits that mandatory ESG disclosure
regulation brings, this supports the argument for changes in countries that do
not have mandatory ESG disclosure regimes.
The authors’ evidence shows that the gap between supply of
and demand for ESG information may be bigger for firms headquartered in common
law countries, suggesting a greater need for mandatory ESG disclosure regulation
in those countries.
“This important research confirms that enhanced disclosure of ESG information can inform idiosyncratic or company-specific price discovery for investors. But it also importantly demonstrates that information access can reduce systemic risk by reducing the likelihood of market crashes. While some regulatory jurisdictions are already moving to enhance ESG disclosure requirements, hopefully this new research will help bring those on the fence onto the other side, particularly regulators with systemic risk management in their mandates.”
Any views expressed
here are those of the author as of the date of publication, are based on
available information, and are subject to change without notice. Individual
portfolio management teams may hold different views and may take different
investment decisions for different clients. The views expressed in this podcast
do not in any way constitute investment advice.
The value of
investments and the income they generate may go down as well as up and it is
possible that investors will not recover their initial outlay. Past performance
is no guarantee for future returns.
Investing in emerging
markets, or specialised or restricted sectors is likely to be subject to a
higher-than-average volatility due to a high degree of concentration, greater
uncertainty because less information is available, there is less liquidity or
due to greater sensitivity to changes in market conditions (social, political
and economic conditions).
Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.
Writen by Sustainability Centre. The post Mandating ESG disclosures really makes a difference appeared first on Investors’ Corner – The official blog of BNP Paribas Asset Management, the sustainable investor for a changing world.
Jim Chanos: China’s “Leveraged Prosperity” Model Is Doomed…And That’s Not The Worst Of It
Jim Chanos: China’s "Leveraged Prosperity" Model Is Doomed…And That’s Not The Worst Of It
Authored by Lynn Parramore via The Institute for…
Jim Chanos: China’s “Leveraged Prosperity” Model Is Doomed…And That’s Not The Worst Of It
Famed short-seller is even more concerned with political fallout from Evergrande than economic/financial woes.
Renowned short-seller Jim Chanos, founder of Kynikos Associates, is what you might call the “ever-bear” of China. For more than a decade, he has warned that the country was building a real estate-driven economy on a feeble house of cards. He spoke to the Institute for New Economic Thinking’s Lynn Parramore about how he views the chickens coming home to roost as the property giant Evergrande – now the world’s most indebted property developer — teeters on the verge of collapse.
Lynn Parramore: Back in ’09, when you started looking at China, your real estate analysts alerted you to the mind-boggling amount of real estate overdevelopment there. You warned that this overdevelopment would end badly. After Xi Jinping became president in 2013, you expressed the then-minority view that a different kind of leader had arrived on the scene. What’s your take on what has happened since then?
Jim Chanos: In 2013, we put a slide in our presentation for investors and talks that was very controversial – especially for Chinese nationals. It showed President Xi Jinping in emperor’s garb. People thought we should take it out, that it was offensive. At the time, Xi was widely seen as just the latest in a series of technocrats who had risen through the ranks — one who would follow along with Deng Xiaoping’s reforms. It’s “capitalism with Chinese characteristics.” It’s okay to get rich as long as the country prospers.
But a few things made us think, no, this guy is different. His first speech in China after becoming president was critical of the Soviet Union for being soft on perestroika. They should have crushed it when they had the chance, he said. Xi then set up an institute to study the Soviet Union’s collapse. That was a red flag to us that he was going to be more hardline than people thought. He went on to do an anti-corruption drive, which people dismissed as a typical settling of scores that Chinese leaders do. But it actually extended beyond that. A couple of years later, he began talking in Puritanical terms about social issues. Again, that was different. Nobody had cared about that stuff for 20 years. Do what you want as long as you don’t question the party. Next, we had the book collecting his speeches and writings, which people could be seen carrying around. He started showing up in military events dressed in Mao jackets. This symbolism isn’t lost in China.
We noticed all this, but the real switch occurred in 2019 when he started going after celebrities like Jack Ma [co-founder of Alibaba]. At that point, it was clear that this president was not stepping down at the end of 10 years. He was taking a much harder line on the “flowers of capitalism,” if you will, than past presidents. In 2021, all of this exploded into the open. There’s been initiative after initiative. Redistributing wealth to the masses. Going after other leaders. Overlaid on top of this is the Evergrande saga.
LP: Let’s talk about Evergrande, the Shenzhen developer whose crisis has got everybody worried. How did things get so bad?
JC: Last year, as the tech crackdown was gaining momentum, Xi’s administration put down a set of rules called the “three red lines.” They were sort of balance sheet financial tests. It was an attempt to deleverage the real estate developers.
LP: Which means he knew something was wrong.
JC: Well, here’s the problem. I always joke that when you have an investment-driven economic model, you know your annual GDP on January 1st of that year, because you can stick shovels in the ground to make your growth numbers. That’s how the model works. It’s not a consumption-based model. As we now know — and the Wall Street Journal just had some phenomenal numbers in a recent piece – that real estate construction is now larger than it was when he took office. I would always hear, well, don’t worry: these are smart guys, technocrats who see the problem and will wean themselves off this apartment construction-on-steroids. But they haven’t.
LP: Why haven’t they been able to slow it down?
JC: Since we started following China at the end of ’09, this is the fourth time that they’ve attempted to slow the real estate market down, because they do know that this is going to be basically too big to deal with if it keeps growing at the rate it’s growing. But every time they’ve done it, the economy has hit stall speed very quickly, and they panicked. They went from hitting the breaks to hitting the accelerator. That’s why we’ve seen higher levels of real estate. The idea that “I can’t lose buying apartments” became ingrained with bankers, real estate speculators, and the public.
LP: So with Evergrande, everyone came to expect a bailout?
JC: I think we’re at that crossroads. The problem is that these companies are so much bigger than they were in 2015 or 2011. Can you bail everybody out? In the case of the developers, you have an additional problem. The biggest amount of liabilities is not necessarily to banks and bondholders. It’s to apartment buyers. Here’s why: the Chinese real estate finance system is exactly the opposite of ours. In our system, when there’s a new development, you’re typically required to put 10% down to sign a contract, with the balance due on closing. You go get your financing and your mortgage proceeds pay for the rest of the house or the apartment. In China, you pay upfront. You are extending the developer a loan. So, of the $300 billion in liabilities Evergrande owes, I think the biggest chunk, last time I checked, is basically what we would call a deferred revenue item. It’s money that you took in from people, and you owe them an apartment. And the apartments aren’t done, but the money’s been spent. So the problem is not just bailing people out, but the question of who is going to put up more capital to pay off the retail people that have bought apartments that haven’t gotten anything.
These numbers are big, and Evergrande is not the only one. There are a handful of developers that are missing interest payments and have their bond prices reflecting distress.
LP: How much has corruption played a role in this mess?
JC: That’s a problem with their economic model focusing so much on real estate. Because they don’t have a local tax system, like property taxes, the local governments sell land to pay for local services. But whenever you have private developers buying land from municipalities controlled by one party, yeah, it’s ripe for corruption. We know that’s rampant in China.
LP: How do you view the policy reaction to Evergrande?
JC: So, what do the policymakers do? It’s not a Lehman moment in that there’s not a lot of cross-border interbank lending here. The Chinese system is still pretty much a closed financial system. That’s not the risk. During the Global Financial Crisis [GFC], what brought us to our knees was the liability side of the banks’ books. They couldn’t roll over the loans to each other because no one trusted the assets. Here, it’s the assets. I think that if they try to inflate it again, if they try to bail it out again, we’re only going to be right back in this soup in another two or three years, with even bigger problems.
LP: Is this only a problem with the real estate sector, or is it more extensive?
JC: Based on our analysis of the numbers – and you have to take the Chinese numbers with more than a shaker of salt – we’ve long thought that residential real estate was probably 20% of GDP and that all in, real estate construction and related services was about 25%. Ken Rogoff came out with a study last year that said it was 29%. That’s already a huge amount compared to other countries.
Well, the numbers that the Wall Street Journal just put out were staggering, implying that there were 1.6 million acres of residential real estate under construction. If you do the math, it’s the equivalent of 72 million apartments. We believed that they were selling 20 million a year, but the WSJ story seems to imply that the numbers are actually much, much bigger. That tells me that our numbers and Rogoff’s numbers regarding GDP are probably on the low side. It could be a 30-40% problem, not a 20-25% problem. It’s just magnitudes bigger. We’ve never seen anything like this. And there’s no game plan, no historical analog. Maybe Tokyo in ’89? But this is worse than that. It’s worse than Spain in ’06 or Ireland in ’06. We’ve just never seen an economy this dependent on putting up apartment buildings — apartments that nobody is residing in. Everybody already has an apartment! These additional ones are second and third apartments at this point, and only for people who can afford them because they’re extremely expensive.
I think the Chinese government has convinced themselves that by borrowing lots of money from their own citizens and elsewhere, that there’s ongoing activity that is sustainable. But as we find out in every real estate bubble that bursts, when your activity is constructing real estate itself and you’re taking capital and turning it into income by paying construction workers and real estate brokers and everybody else, when that activity ends, it goes poof! And there’s no income from the asset you’ve just financed. It’s not like building a factory where you have demand for your products. It’s just apartments sitting empty in Beijing or Shenzhen.
LP: How does this problem relate to Chinese politics?
JC: As all of this is happening on the financial and economic front, along with the crackdown on business elites, we’ve seen a commensurate rise in bellicosity, in saber-rattling toward Taiwan, India, and Tibet. We’ve seen a much more aggressive posture from Xi in relating to the West. Now every day there’s a warning in one of the Chinese Communist Party organs threatening Australia if they come to Taiwan, threatening Japan. I don’t know if the Party is preparing the citizenry for a “them.” Someone to blame.
LP: As we’ve seen with the pandemic already.
JC: Yes, and in the way they’ve treated the West’s outrage about the concentration camps in Xinjiang province. That’s the classic authoritarian move. We know it from our own country. Blame someone. “It’s their fault, not our fault.” We need an enemy. I don’t know how real the saber-rattling is. Is it a distraction from domestic belt-tightening that’s coming? Planting the idea that we’re going through hard times because the whole world is against us? We’ll see. It’s an incredibly interesting time to be watching China.
LP: What does it all mean to the rest of the world?
JC: Again, I think it’s not a financial transmission issue reverberating through the financial systems and markets. I do think that it will affect global growth. China was a full point of the 3% global real growth we’ve had since the GFC. Without China, it’s 2%. So China itself, by growing 7 or 8% a year was a disproportionate amount of global growth. It’s also going to impact what I call Greater China, which is Taiwan, South Korea, Singapore – the areas that trade very actively with China. And it will definitely impact commodity exporters. In this massive build-out, China has continued to suck in iron ore and copper and all kinds of things from a variety of different countries like Brazil and Australia. But I think that the impact might be more political than financial. That’s what worries me.
LP: How would you characterize these worries?
JC: It’s the rise of bellicosity, the rise of a more militant China as the economy and the financial situation has gotten more precarious. That’s a 1930s kind of problem. We know that a rise in authoritarianism and statism around the world was one of the upshots of ’29-’32. You had leaders saying, “I’m the one that can get us out of this problem” and “They are the ones who got us here.” This situation in China is a little bit frightening to the student of history, because there’s no doubt, whether you’re flying over Taiwan airspace or coming close to ships in the South China Sea, that there’s a rise of tensions in and around China. I don’t think it’s a coincidence.
LP: To touch on Xi’s crackdown on the tech industry, how do you view that in the context of the need to lessen this dependency on the real estate sector? Certainly, we can see in our own case with Silicon Valley — Facebook and so on — that poorly regulated tech is a problem. But what does Xi’s stance mean in the context of his desire for China to be a leader in innovation, on the cutting edge of technology?
JC: That was always one of the responses to our concerns about the investment-driven model. People said, well, everyone does everything on their smartphone in China. They’re far more advanced in social media than we are and more advanced in payment systems, and so on.
The problem was that, number one, it gave rise to these global tech celebrities, and number two, I think China, or the Party, realized a little bit later than they might have that the control of databases and information that these companies have is certainly a power center. And the one thing that the Communist Party cannot brook is a threat to its control. There are no other political parties, no free press. The only thing that could challenge control is the thing that people said would liberalize China – the internet. Access to the internet, access to ideas, access to global media. People thought these things would democratize China, but Xi is saying no: we’re going to put up a Great Firewall and we’re not going to allow Alibaba to have as much power as the Party.
LP: And it looks like he’s going after the banks next.
JC: The real estate system is so big, and so levered – the banking system has grown with it, of course. It seems to me that Xi is basically going through all the power centers — technology, finance, etc., and cracking down. He’s making sure his people are completely in charge and that there’s no interference, no other power centers. And it makes me ask why. What’s the end game? I mean, the Party has control of the country for the most part. The citizens understand that. So why? What is coming that he feels he needs to make sure that all of his people are in control? I can’t help but think of Stalin. The end game puzzles me the most. Is it to prepare for a takeover of Taiwan? To be more forceful on the international stage? I don’t know.
LP: What is distinct about China’s vision of capitalism in the context of a one-party system? What are its particular features and challenges?
JC: What distinguishes China and what makes it so unique from my perspective, putting on the financial historian’s hat, is that the speed at which they developed was unprecedented, and the amount of risk they have taken to do that is unprecedented. Their banking system is now the largest in the world. The amount of real estate construction is just completely insane, and until, perhaps, this past 12 months, we haven’t seen a real, serious effort to say, “Maybe we should rethink this fantasy where everybody is going to have six apartments. Maybe we need to do other things in our economy to balance it out.”
How are they going to deal with the transition? Because they’re going to have to do it at some point. I think it’s going to be fascinating to see how they try to get out of it. Do they switch spending to defense spending? Do we get an arms race? Can they keep a closed currency? There are a whole lot of big questions.
They’ve got to make some tough decisions on how the economic model is going to work going forward. In the late ‘80s, everybody thought Japan was going to surpass the U.S., but they had the same problems – a banking system that was bloated, real estate prices too high, too dependent on exports, and they’ve had 30 years of muddling through. The idea that China is going to be growing 6 or 7% while the rest of the world is growing 2% just has to be revisited. It’s not gonna happen. That realization is going to be the bucket of cold water that’s going to force them to rethink next steps. The population has been used to this leveraged prosperity, and everybody has borrowed money to buy real estate. What are the next steps? It’s otherworldly what they have done with real estate. Whatever happens, it’s going to be severe somehow. Whether it’s politically or financially — whatever it is, it’ll be severe.
What Are Bond Yields & Breakevens Telling Us?
#CKStrong Carol K.’s ANC broke above 1200 today. Absolute Neutrophil Count (ANC ) measures a type of white blood cell that kill and digest bacteria…
Carol K.’s ANC broke above 1200 today. Absolute Neutrophil Count (ANC ) measures a type of white blood cell that kill and digest bacteria and fungi to help the body fight infections and heal wounds. At a time around Day 0 of her stem cell transplant, it was below 100, which is severe neutropenia and often fatal for cancer patients. Her fight and grit coupled with the combination of the miracle of modern medicine, deep resources, and all of your support — prayers, positive thoughts and energy, and other — around the world created this miracle. Thank you so much to all of you. She will be discharged after a 5 1/2 month hospital stay in isolation in early Novie. Halle-freaking-lujah!
A very close friend posed the question in this post’s title to me the other day.
I laughed and said, “are you kidding me? I mostly ignore the bond market flapdoodle as it was nationalized long ago. Bond yields and breakevens are about as relevant as the price of sausage, Back In The USSR! Ergo, the bond market is not a real market with real price discovery.
Baby, It’s Foggy Outside
Unfortunately, policymakers continue to make policy based on totally distorted flight instruments, which is very dangerous when it gets foggy. The economy is foggy today, folks.
Here’s PK starting to waffle, and seems, to us, he may be considering playing out his option on Team Transitory,
Why is it so hard to make a call on inflation right now? Because the current economy, still very much shaped by the pandemic, is, to use the technical term, weird. In particular, the standard measures economists use to distinguish between temporary price blips and underlying inflation are telling different stories. – Paul Krugman, NY Times
Krugman’s piece is a must read.
Fed Intervention In The “COVID” Bond Market
Maybe if we had a free bond market, we would have seen this inflation spike coming through a real and true bond yield and breakeven price.
The conventional wisdom is that the Fed has financed 40-50 percent of the debt the U.S. Treasury has put on its books during COVID, and that is confirmed by the data at 46.6 percent of all new issuance, including Treasury Bills. We dig deeper in the following table.
Look at the profile of the new debt that financed the COVID deficit, however.
The Fed has effectively purchased 75 percent of all new note and bond issuance and 160 percent TIPs issuance from March 2020 to September 2021. If they hadn’t, interest rates would have spiked higher, maybe 500 bps higher, and it is possible some of the auctions would have failed.
Why doesn’t the Treasury fund itself with more longer-term debt to lock in the lower rates? Because they can’t, which illustrates why T-Bill issuance was up $2.5 trillion during COVID.
Moreover, if you are going to repress coupon yields from moving to their equilibrium, you must also do the same in the TIPs market, otherwise breakevens would have gone wild and made no sense, especially given its a relatively illiquid market.
If there was real price discovery in the bond market, it may have tipped us off about a coming inflation spike and what markets really think about the path of future inflation. After all the supply curve broke last year, so there was plenty of time for the bond market to get it right. See our post, Hot Retail Sales Not Supply Chain Positive.
Financing Of The Monthly Budget Deficits
The following chart illustrates the path of the U.S. monthly budget deficits (red line) during COVID and how they were financed.
Treasury finances itself either through: a) borrowing from the public (black line), b) reduction in operating cash. mainly in its General Account at the Federal Reserve (blue line), which is down from $1.8 trillion in July 2020 to a measly $78 billion on October 13 (see here), and confirms Secretary Yellin’s assertion the government is almost out of cash, and through c) other means, such as running arrears on Treasury contributions to federal government employee pension funds, to suppliers, and other extraordinary ways.
We suspect “defaulting on the debt” as an “other means” financing is a bluff as the government will look for other bills and/or entitlements run up arrears on to conserve cash and prioritize spending.
Tapping The Market When It Can
The chart also shows that Treasury seems to very good at tapping the market when there is a flight to quality bid. Note how almost 70 percent of the borrowing from the public took place during March 2020 to June 2020, and exceeded the cumulative deficit during that period by 50 percent. The differential went to build reserves in the Treasury’s General Account.
Even still, the Fed bought the equivalent of about 55 percent of all new borrowing during March 2020 to June 2020.
Debt Ceiling Politics
Nevertheless, the political cost to the Administration of using other means as a source of financing, say, suspending Social Security payments, if legal, is certain political death, and that, folks, is the game that is playing out in Washington today.
Forget about advancing the national interest, just destroy the opposition, and to be fair, it always seems M&M is on the wrong side of this issue.
(the sum of the three non red lines in the chart above will equal the red deficit line)
It is interesting that the Treasury’s borrowing from the public (black line) is constrained by the debt ceiling has been negative over the past few months, all while the Fed is taking $80 billion per month in Treasury securities out of the market. No wonder why bond yields dipped during the summer, which some took as “everything is perfect,” deflation is coming, or, we hope not, the policymakers took it as inflation is under control.
It is almost laughable to hear comments, such as
Is inflation caused by [monetary] inflation or by the supply chain problems.
These are coming from major market pundits, who appear, and we could be wrong, they don’t even understand the basic concepts of inflation, much less where it comes from and how to stamp it out.
My experience working with the high to hyperinflation central banks back in the day was there were lots of shortages throughout the economy. No bread on the shelf at grocery stores because of hoarding and a breakdown in…wait for it…local supply chains.
We seriously doubt we get there, if the FOMC does its job. They tell us they have the tools but do they have the stomach? Starting to smell a bit of panic the Fed is offsides and needs to move quicker.
Stay tuned, folks.
As always, we reserve the right to be wrong in our conclusion as we are pretty certain we have the facts (data) right. We like to tell this story about getting your conclusion wrongs.
Facts Right, Conclusion Wrong
President Lincoln, a great storyteller, had something to say about drawing different conclusions from the same established or, what economists like to call “stylized facts,”
During his days as an Illinois circuit court lawyer, legend has it Lincoln would persuade juries with the use of his funny but truth piercing stories,
The story goes that Lawyer Lincoln was worried he had not convinced the jury during the closing argument of a civil case against a railroad. The jurors had gone to lunch to deliberate. Lincoln followed them and interrupted their dessert with a story about a farmer’s son gripped by panic,
“Pa, Pa, the hired man and sis are in the hay mow and she’s lifting up her skirt and he’s letting down his pants and they’re afixin’ to pee on the hay.” “Son, you got your facts absolutely right, but you’re drawing the wrong conclusion.”
The jury ruled in Lincoln’s favor.
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