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Bill Ackman wants the Fed to hurry up: is he right?

Bill Ackman, the founder of Pershing Square Capital Management is a well-known voice in the financial markets. In his recent tweets, Ackman took aim at…

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Bill Ackman, the founder of Pershing Square Capital Management is a well-known voice in the financial markets. In his recent tweets, Ackman took aim at Jerome Powell and the Federal Reserve for not acting decisively enough to curb sky-high inflation. He stressed that inflation was now out of control and worse, that the markets no longer had confidence in the Fed. In his view, the Fed must commit to a substantial increase in rates to bring price rises within the target range. He believes that the current policy is “setting us up for double-digit sustained inflation”, and is responsible for the bloodbath in equity markets. If the Fed seizes the moment, Ackman feels equities can recover well.

Widespread fears of runaway inflation have changed from keep-me-up-at-night horror stories to eye-watering prints of over 8%. Such a situation was scarcely imaginable for most even till last year. Ackman is correct to point out that the Fed’s misses since the Great Recession have gravely dented its credibility as the inflation fighter.

Despite the best efforts of the collective mind at the Federal Reserve, inflation was nigh unmovable for years, staying well below the oft-touted 2% target. As Noah Smith wrote, “economists don’t really have theories that can predict things like inflation or unemployment with any sort of reliability”.

Inflation is a hard problem, and the markets are wise to the fact that no one fully understands how to address it.

Of course, today, the challenge is very different. The issue is not too little but too much. High inflation in a sense is a better problem for policymakers, because the primary weapon of interest rates hikes re-discover their potency. However, as we shall see, there are caveats to this.

Firstly, the unprecedented turnaround in inflation was not due to the magic of zero-interest policies but a host of external factors – the unprecedented covid pandemic, subsequent lockdowns, the gargantuan injection of fiscal stimulus, and most recently, the outbreak of the Russia-Ukraine war.

The majority of these factors are well outside the control of the Federal Reserve.

More so than the failures of monetary policy from 2008 onwards, the Fed’s image has been irreparably tarnished by its insistence that inflationary pressures were ‘transitory’. The combination of ultra-loose economic policy, simmering tensions, and unwillingness to acknowledge the gathering clouds, thrust inflation from the high asset prices of Wall Street to supermarkets on Main Street.

This loss of credibility should theoretically render the Fed less effective, and dilute its ability to guide the narrative to the promised land of a low-inflation soft landing.

How much should rates be raised?

Interest rates are designed to work primarily through a demand channel. The thinking is that higher rates reduce demand, and reduced demand lowers inflation. In Q1, GDP contracted amid higher international oil prices which reverberated through the production chain; and a widening trade gap. Demand growth was robust but this may be somewhat illusory, occurring on the back of low unemployment, savings, and earlier fiscal injections.

Domestic supply chains in the United States are yet to fully recover after two years of public health restrictions, while global sea freight indexes have declined for the third month running. Crucial imports such as fertilizers are in short supply with the onset of the Ukraine-Russia war and subsequent sanctions. Gasoline prices in particular have surged to $4.6, hurting the average American.

Suffice it to say that much inflation is supply-driven, blunting the use of policy rates to bring the economy closer to the 2% level.

Even though the Fed has tried to present a brave face, as Ackman points out, 2-3% increases in the rates are unlikely to contain inflationary pressures and are not nearly high enough. Usually, one may expect that interest rates would need to be higher than inflation to be effective. In Paul Volcker’s era, rates were raised to a record 20% to restrain consumer prices that reached 13% year over year.

Specifically, Ackman says that the rates should immediately be raised to the neutral rate.

The neutral rate is a theoretical construct – the rate where growth is not restricted by being too high, nor a rate so low that inflation is beyond control. As Ackman argues, if the rates are neutral, inflation can be managed without causing a recession (or worse). The big problem with that assertion is that no one knows where the neutral rate lies, with James Bullard of the Federal Reserve calling it “The Phantom Menace”.  

Unfortunately, no bag of Jedi mind tricks can help here, and the Fed is much more likely to either overshoot or be under the neutral level. Ackman’s tweets and the current rate hike hesitancy suggest that the Fed is destined to be well below this, and consequently, unable to restrain inflation.

The Wage-Price Spiral

In developed markets such as the United States, wages play a major role in inflation. Ackman points to the “wage-price spiral”. This is the idea that as unemployment falls, workers gain bargaining power and demand higher wages. As wages rise, companies find costs go up and employees have more money to spend. This combination leads to higher prices, pushing workers to ask for higher wages, perpetuating inflation. Today, Ackman sees this as a big concern, due to unemployment falling to a low level of 3.6%.

The wage-price spiral was central to the high inflation of the 1970s-80s. However, today, opinions vary if the US is really in such a situation. The biggest challenge to a wage-price spiral in the United States is the lack of labor power. In the 1970s, labor unions were very powerful entities that could secure higher wages through collective bargaining. This changed with the onset of globalization. The US suddenly had access to a much broader labor pool, and this naturally reduced wages. Outsourcing and the introduction of technologies such as industrial automation further weakened labor’s collective bargaining power. As a result, it is unclear if workers can demand higher wages to keep pace with inflation.

Even though companies have been raising nominal wages, they have not kept pace with inflation. Inflation-adjusted wages have actually fallen 3.6% in the past 12 months.

As nominal wages climb but real wages fall, this may prompt exits from the job market resulting in the tight labor market being only a temporary phenomenon. If the job market happens to weaken, the Federal Reserve may be reluctant to raise rates as aggressively, since a major contributor to inflation would be absent.

Sustained rate hikes?

Although the Federal Reserve has certainly shown greater initiative to raise rates than what has been typical in recent years, it is uncertain how sustainable this may be. For instance, in 2019, the Fed was forced to reverse course on its policy normalization objectives. History suggests that any instance of imploding equities and burgeoning debt payments amid lowered growth projections could force a reversal from Powell and company.

In a bear market, with easy money drying up, inflated asset values, and a multitude of zombie companies, are likely to crumble. If stocks fall, this may cascade into the real economy and reduce employment, again possibly forcing a course adjustment.

Today, with GDP contracting and eight successive weeks of declining equities, raising rates would likely have catastrophic effects leading to rising debt burdens in a country fueled by credit-driven consumerism, precipitating a deep recession.  This would be met by social upheaval and a popular backlash that may weaken the Fed’s resolve into U-turning.

The markets, now accustomed to free money, have little appetite for continuing rate hikes. With the interest rate cycle barely having begun, there are murmurs among financial players of a “Fed pause”, or an interval (so to speak) after September. As Ackman has tweeted, in recent times, the Fed communications themselves have suggested some officials believe that there may be scope to Pause.

Analysts at Brown Brothers Harriman wrote, “The views expressed in the minutes are about all they could say at the start of an aggressive tightening cycle where no one really knows how far rates have to go.” John Vail of Nikko Asset Management believes that the Fed will not go for a Pause because it will continue to attack inflation regardless of the source (supply and not demand-led). In addition, an interrupted rate hike cycle will likely ensure inflation stays for longer.

Although Ackman’s prescription would artificially destroy demand and likely stem inflation, the dose would not only have to be very high to be effective, but the medicine itself would be very difficult to keep taking.

Despite the pain involved, Ackman is right that if the Fed does not react or does not react fast enough, “the market will do the Fed’s job”. This is quite like exactly what will happen, as inflation will continue unabated, although pressures may be limited if a wage-price spiral does not materialize. Consumers will buckle down and businesses will be forced to cut back, leading to a crash in the stock market, wiping out savings and asset values, and finally resulting in a deep demand deficit.  

Inflation Outlook

Some commentators argue that inflation may have peaked already. Even so, the inflation genie is out of the bottle and likely to persist. Supply disruptions and inflation expectations don’t reset instantly. To add to this, the Ukraine war still rages and the full effects of monkeypox are yet to be ascertained. In a worst-case scenario, Chinese measures over the weekend to end covid lockdowns may only prove temporary. Leading inflation indicators such as PPI are elevated at above 11%. Ackman is right to suggest that without swift action, prices will continue to climb and persist into the coming year.

Even if a fortuitous series of happenstances were to magically combine, this would likely not be sufficient to lower inflation to the 2% level.

As discussed earlier, monetary policy is not the only thing affecting inflation, but it is the only aspect that the Fed can exert control on.

In the US, inflation also occurs from structural problems such as a lack of modern transportation, poor infrastructure, costly healthcare, low productivity, and aging demographics. These can’t simply be alleviated by altering monetary policy, and will likely keep inflation sticky. Rates would have to be kept very high for a prolonged period, harboring major risks to the economy.

However, if interest rates are aggressively hiked, the ensuing recession will prevent crucial investments in these troubled sectors, contributing to inflation.

According to Dr. Komal Sri-Kumar, macroeconomic advisor and senior fellow at the Milken Institute, “The Fed is in an impossible situation”, and believes that higher rates would result in a 2008-style recession.

A Final Word

To meaningfully restrain inflation, the Fed will have to aggressively front-load interest rates as Ackman suggests. They may also have to rise above the level of inflation and would likely have a very limited impact in the low single digits.

However, high rates would cause significant pain to households, leading to demand destruction in an environment that is already showing signs of broader contraction. For May, the University of Michigan’s US Consumer Sentiment gauge fell from 65.2 to 58.4, reflecting economic fragility.

Dr. Komal Sri-Kumar believes that the opportunity for a softer landing has passed by in mid-2021. In his view, the Fed could have opted to raise target inflation to between 3%-3.5% and hiked rates accordingly. By delaying the process of normalization, he feels that the Fed “lost degrees of freedom”.

Mohamed El-Erian, Chief Economic Advisor at Allianz, agrees that the Fed has left it too late and “should have started hiking nine months ago to put the economy in a position for a so-called soft landing”. Worryingly, he added, “I think the Fed is going to have to decide between two policy mistakes: hit the brakes too hard and risk a recession or tap the brakes in a stop-go pattern … and risk having inflation well into 2023.”

The higher the rates climb; the greater harm would come to the economy. In such a situation, it is difficult to imagine equities performing well. Although Ackman expects at least real business stocks to rebound, this is far from guaranteed in a scenario where demand has collapsed.

Even though his views are clear, it may be difficult to implement Ackman’s ideas, or even agree upon how to deliver them. On the other hand, not delivering on this, could damage the Fed’s reputation further, while high inflation will continue to persist.

As it stands, the Fed is caught between a rock and a hard landing.

The post Bill Ackman wants the Fed to hurry up: is he right? appeared first on Invezz.

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Economics

Here’s Why Royal Caribbean, Carnival Stock Are Good Buys

Yes, Carnival reported a bigger-than-expected loss but in this case, unlike taking a cruise, it’s the destination not the journey for the cruise lines.

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Yes, Carnival reported a bigger-than-expected loss but in this case, unlike taking a cruise, it's the destination not the journey for the cruise lines.

For the past two years, since the covid pandemic hit in late-February 2020, the cruise industry has taken one punch after another. And, while the situation has improved from the extended period when cruises were not allowed to sail from United States ports, that does not mean that it's back to 2019 for Royal Caribbean International (RCL) - Get Royal Caribbean Group Report, Carnival Cruise Line (CCL) - Get Carnival Corporation Report, and Norwegian Cruise Line (NCLH) - Get Norwegian Cruise Line Holdings Ltd. Report.

The industry has done a remarkable job bringing operations back to near-normal. All three cruise lines not only have put all their ships back in service, they're also still moving forward with plans for new ships and other investments including improvements to private islands, and developing new ports.

That being said, Carnival just reported its second-quarter earnings and the market did not like the numbers at all. Shares of all three cruise lines were down double digits on Sept. 30, but traders clearly missed that aside from rising costs and a loss (both of which were expected) the cruise line largely delivered good news.

Image source: Shutterstock

Carnival Did Well in Areas it Controls  

Carnival reported a GAAP net loss of $770 million for the quarter. That was driven by higher costs with the company specifically citing advertising expenses and having some of its fleet unavailable to produce revenue.

While the company's year-to-date adjusted cruise costs excluding fuel per ALBD during 2022 has benefited from the sale of smaller-less efficient ships and the delivery of larger-more efficient ships, this benefit is offset by a portion of its fleet being in pause status for part of the year, restart related expenses, an increase in the number of dry dock days, the cost of maintaining enhanced health and safety protocols, inflation and supply chain disruptions. The company anticipates that many of these costs and expenses will end in 2022.

If you're investing in any cruise line you have to do so on a very long-term basis. That makes profitability less of a concern than the company building back its business and Carnival showed some very positive signs in that direction.

  • Revenue increased by nearly 80% in the third quarter of 2022 compared to second quarter 2022, reflecting continued sequential improvement.
  • Onboard and other revenue per PCD for the third quarter of 2022 increased significantly compared to a strong 2019
  • Total customer deposits were $4.8 billion as of August 31, 2022, approaching the $4.9 billion as of August 31, 2019, which was a record third quarter.

  • New bookings during the third quarter of 2022 primarily offset the historical third quarter seasonal decline in customer deposits ($0.3 billion decline in the third quarter of 2022 compared to $1.1 billion decline for the same period in 2019).

Carnival (and likely all the cruise lines) is being hurt by prices generally being depressed and some passengers paying for their trips using future cruise credits from cruises canceled during the pandemic. That's not really what matters though. Carnival has been increasing passenger loads and getting people back on its ships.

"Since announcing the relaxation of our protocols last month, we have seen a meaningful improvement in booking volumes and are now running considerably ahead of strong 2019 levels," Carnival CEO Josh Weinstein said. "We expect to further capitalize on this momentum with renewed efforts to generate demand. We are focused on delivering significant revenue growth over the long-term while taking advantage of near-term tactics to quickly capture price and bookings in the interim."

Basically, cruise prices are cheap right now because it's more important to get customers back on board than it is to maintain pricing integrity. That's a tactic that could hurt long-term pricing, but the cruise industry is less vulnerable than other vacation options because there have always been large pricing variations based on the calendar and the age of the ship being booked.

It's a Long Voyage for Cruise Lines

Carnival was trading at its 52-week low after it reported. That's a pretty major overreaction given that the cruise industry was barely operating in the fall of 2021.

Yes, the industry has a long way to go. All three major cruise lines took on billions of dollars of debt during the pandemic. Refinancing that debt in an environment with higher interest rates is a challenge, but it's one Carnival (and its rivals) have been meeting.

That has come with some shareholder dilution. Carnival sold $1.15 billion in new stock during the quarter, but the company has over $7.4 billion in liquidity. Weinstein is optimistic (he has to be, that's part of his job) about the future.

"During our third quarter, our business continued its positive trajectory, achieving over $300 million of adjusted EBITDA and reaching nearly 90% occupancy on our August sailings. We are continuing to close the gap to 2019 as we progress through the year, building occupancy on higher capacity and lower unit costs," he said.

Usually it's easy to dismiss a CEO making upbeat comments after posting a loss, but in this case, Carnival has basically followed the recovery path it laid out once it returned to sailing. Both Royal Caribbean and Norwegian have followed similar paths and while meaningful shareholder returns may take time, these are strong companies built for the long-term that made a lot of money before the pandemic and should do so again. 

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Spread & Containment

Three reasons a weak pound is bad news for the environment

Financial turmoil will make it harder to invest in climate action on a massive scale.

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Dragon Claws / shutterstock

The day before new UK chancellor Kwasi Kwarteng’s mini-budget plan for economic growth, a pound would buy you about $1.13. After financial markets rejected the plan, the pound suddenly sunk to around $1.07. Though it has since rallied thanks to major intervention from the Bank of England, the currency remains volatile and far below its value earlier this year.

A lot has been written about how this will affect people’s incomes, the housing market or overall political and economic conditions. But we want to look at why the weak pound is bad news for the UK’s natural environment and its ability to hit climate targets.

1. The low-carbon economy just became a lot more expensive

The fall in sterling’s value partly signals a loss in confidence in the value of UK assets following the unfunded tax commitments contained in the mini-budget. The government’s aim to achieve net zero by 2050 requires substantial public and private investment in energy technologies such as solar and wind as well as carbon storage, insulation and electric cars.

But the loss in investor confidence threatens to derail these investments, because firms may be unwilling to commit the substantial budgets required in an uncertain economic environment. The cost of these investments may also rise as a result of the falling pound because many of the materials and inputs needed for these technologies, such as batteries, are imported and a falling pound increases their prices.

Aerial view of wind farm with forest and fields in background
UK wind power relies on lots of imported parts. Richard Whitcombe / shutterstock

2. High interest rates may rule out large investment

To support the pound and to control inflation, interest rates are expected to rise further. The UK is already experiencing record levels of inflation, fuelled by pandemic-related spending and Russia’s war on Ukraine. Rising consumer prices developed into a full-blown cost of living crisis, with fuel and food poverty, financial hardship and the collapse of businesses looming large on this winter’s horizon.

While the anticipated increase in interest rates might ease the cost of living crisis, it also increases the cost of government borrowing at a time when we rapidly need to increase low-carbon investment for net zero by 2050. The government’s official climate change advisory committee estimates that an additional £4 billion to £6 billion of annual public spending will be needed by 2030.

Some of this money should be raised through carbon taxes. But in reality, at least for as long as the cost of living crisis is ongoing, if the government is serious about green investment it will have to borrow.

Rising interest rates will push up the cost of borrowing relentlessly and present a tough political choice that seemingly pits the environment against economic recovery. As any future incoming government will inherit these same rates, a falling pound threatens to make it much harder to take large-scale, rapid environmental action.

3. Imports will become pricier

In addition to increased supply prices for firms and rising borrowing costs, it will lead to a significant rise in import prices for consumers. Given the UK’s reliance on imports, this is likely to affect prices for food, clothing and manufactured goods.

At the consumer level, this will immediately impact marginal spending as necessary expenditures (housing, energy, basic food and so on) lower the budget available for products such as eco-friendly cleaning products, organic foods or ethically made clothes. Buying “greener” products typically cost a family of four around £2,000 a year.

Instead, people may have to rely on cheaper goods that also come with larger greenhouse gas footprints and wider impacts on the environment through pollution and increased waste. See this calculator for direct comparisons.

Of course, some spending changes will be positive for the environment, for example if people use their cars less or take fewer holidays abroad. However, high-income individuals who will benefit the most from the mini-budget tax cuts will be less affected by the falling pound and they tend to fly more, buy more things, and have multiple cars and bigger homes to heat.

This raises profound questions about inequality and injustice in UK society. Alongside increased fuel poverty and foodbank use, we will see an uptick in the purchasing power of the wealthiest.

What’s next

Interest rate rises increase the cost of servicing government debt as well as the cost of new borrowing. One estimate says that the combined cost to government of the new tax cuts and higher cost of borrowing is around £250 billion. This substantial loss in government income reduces the budget available for climate change mitigation and improvements to infrastructure.

The government’s growth plan also seems to be based on an increased use of fossil fuels through technologies such as fracking. Given the scant evidence for absolutely decoupling economic growth from resource use, the opposition’s “green growth” proposal is also unlikely to decarbonise at the rate required to get to net zero by 2050 and avert catastrophic climate change.

Therefore, rather than increasing the energy and materials going into the economy for the sake of GDP growth, we would argue the UK needs an economic reorientation that questions the need of growth for its own sake and orients it instead towards social equality and ecological sustainability.

The authors do not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and have disclosed no relevant affiliations beyond their academic appointment.

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Economics

Covid-19 roundup: Swiss biotech halts in-patient PhII study; Houston-based vaccine and Chinese mRNA shot nab EUAs in Indonesia

Another Covid-19 study is hitting the breaks as a Swiss biotech is pausing its Phase II trial in patients hospitalized with Covid-19.
Kinarus Therapeutics…

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Another Covid-19 study is hitting the breaks as a Swiss biotech is pausing its Phase II trial in patients hospitalized with Covid-19.

Kinarus Therapeutics announced on Friday that the Data and Safety Monitoring Board (DSMB) has reviewed the company’s Phase II study for its candidate KIN001 and has recommended that the study be stopped.

According to Kinarus, the DSMB stated that there was a low probability to show statistically significant results as the number of Covid-19 patients that are in the hospital is lower than at other points in the pandemic.

Thierry Fumeaux

“As many of our peers have learned since the beginning of the pandemic, it has become challenging to show the impact of therapeutic intervention at the current pandemic stage, given the disease characteristics in Covid-19 patients with severe disease. Moreover, there are also now relatively smaller numbers of patients that meet enrollment criteria, since fewer patients require hospitalization, in contrast to the situation earlier in the pandemic,” said Thierry Fumeaux, Kinarus CMO, in a statement.

Fumeaux continued to state that the drug will still be investigated in ambulatory Covid-19 patients who are not hospitalized, with the goal of reducing recovery time and the severity of the virus.

The KIN001 candidate is a combination of the small molecule inhibitor pamapimod and pioglitazone, which is currently used to treat type 2 diabetes.

The news has put a dampener on the company’s stock price $KNRS.SW, which is down 22% since opening on Friday.

Houston-developed vaccine and Chinese mRNA shot win EUAs in Indonesia

While Moderna and Pfizer/BioNTech’s mRNA shots to counter Covid-19 have dominated supplies worldwide, a Chinese-based mRNA developer and IndoVac, a recombinant protein-based vaccine, was created and engineered in Houston, Texas by the Texas Children’s Hospital Center for Vaccine Development  vaccine is finally ready to head to another nation.

Walvax and Suzhou Abogen’s mRNA vaccine, dubbed AWcorna, has been approved for emergency use for adults 18 and over by the Indonesian Food and Drug Authority.

Li Yunchun

“This is the first step, and we are hoping to see more families across the country and the rest of the globe protected, which is a shared goal for us all,” said Walvax Chairman Li Yunchun, in a statement.

According to Walvax, the vaccine is 83% effective against the “wild-type” of SARS-CoV-2 infection with the strength against the Omicron variants standing at around 71%. The shots are also not required to be stored in deep freeze conditions and can be put in storage at 2 to 8 degrees Celsius.

Walvax and Abogen have been making progress on their mRNA vaccine for a while. Last year, Abogen received a massive amount of funding as it was moving the candidate forward.

However, while the candidate is moving forward overseas, it’s still finding itself stuck in regulatory approval in China. According to a report from BNN Bloomberg, China has not approved any mRNA vaccines for domestic usage.

Meanwhile, PT Bio Farma, the holding company for state-owned pharma companies in Indonesia, is prepping to make 20 million doses of the IndoVac COVID-19 vaccine this year and 100 million doses by 2024.

IndoVac’s primary series vaccines include nearly 80% of locally sourced content. Indonesia is seeking Halal Certification for the vaccine since no animal cells or products were used in the production of the vaccine. IndoVac successfully completed an audit from the Indonesian Ulema Council Food and Drug Analysis Agency, and the Halal Certification Agency of the Religious Affairs Ministry is expected to grant their approval soon.

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