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Inflation And Deficits And QT, Oh My -Part 2

Part one of this article discusses the potential ramifications related to policy actions that China and Japan might take. These large U.S. Treasury bondholders…

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Part one of this article discusses the potential ramifications related to policy actions that China and Japan might take. These large U.S. Treasury bondholders could temporarily upset the Treasury market, but as we opined, we do not think they threaten our forecast for lower yields. Like China and Japan, inflation, deficits, and QT are stories bond bears are telling themselves to justify higher yields in the future.

Part 2 focuses on the inflation outlook, burgeoning fiscal deficits, and QT. Like China and Japan, any of the three factors we discuss in this article can briefly upset the bond market. But we do not see inflation, deficits, or QT as a cause of concern for longer-term bond bulls. 

Inflation Expectations

Some are starting to worry that inflation is beginning to rise again. For example, Lawrence Summers shares the graph below, implying that prices will ramp back up.

Given the symbiotic relationship between bond yields and inflation, bearish bond traders are taking notice of new inflation worries. Gasoline, home prices, and some other goods and services are again on the uptick.

While some may be concerned about higher prices, implied inflation, as determined by the bond markets, displays no such fear. As we share below, five- and ten-year inflation expectations continue declining despite bond yields rising sharply.

yields and inflation expectations

CPI will likely continue lower as lagged inflation reporting on shelter costs will catch up to reality. As we wrote in Is Inflation Already At The Fed’s Target? :

CPI with realistic OER and rent prices would be lower than the CPI excluding shelter numbers graphed above. Ask yourself:” What would Fed monetary policy be if inflation was at the Fed’s target?”

The quote references the following graph showing that CPI excluding shelter is 1.019%.

inflation cpi shelter

Bottom line:

We think inflation readings will be lower in six months, albeit may bounce around current levels for a few months before declining. While some think inflation will rise, the markets, in aggregate, have no such concern as we share with implied inflation rates. Therefore, it’s tough to pin the recent yield increases on inflation expectations.

Debt and Deficits

Do federal deficits and associated debt issuance correlate with bond yields?

debt and yields

While many fear sharply increasing deficits will push yields higher, history argues the opposite. Since 1980, yields have fallen precipitously while debt to GDP has increased. Why?

Per Hoisington Investment Management’s latest quarterly update:

Estimates from econometric studies of highly indebted industrialized economies indicate that the government expenditure multiplier is positive for the first four to six quarters after the initial deficit financing, then turns negative after three years. This implies that a dollar of debt financed federal expenditures will, ‘at the end of the day,’ reduce private GDP.

In other words, today’s stimulus is tomorrow’s burden.

Government debt is onerous. Since it is growing much quicker than tax revenue, lower interest rates are required to keep interest expenses affordable for the Government. Further, the burgeoning debt will reduce economic growth and inflation in time. As we show, debt has grown much faster than GDP, tax revenues, and federal interest expenses. However, due to higher interest rates, interest expense has grown more in the last three years than in the fifty years prior. The recent trend is unsustainable!

rate of debt growth versus tax revenue and gdp

Bottom Line:

The market may rightly fret that more debt will increase yields. However, history argues the opposite. The Fed and Treasury know that issuing new debt and rolling over existing debt can’t be done much longer at higher rates. In early August, The Treasury Department announced that it was comfortable letting the share of bills outstanding increase above the recommended level to 22.4%. In other words, they are trying to avoid locking in higher rates for longer.

QT

The Fed is likely to continue QT even after they pause rate hikes. This means that bonds on the Fed’s balance sheet today must find a new home. While that may appear to be a bearish factor for bonds, it’s worth noting the Fed is not selling long-term bonds. They are only letting maturing bonds roll off their balance sheet. In fact, each month, they are a net buyer of long-term bonds. The Fed needs to buy bonds when the amount of their maturing bonds exceeds the $95 billion monthly objective.

The regional bank crisis resulted from banks having to realize losses on long-term bonds and loans. Those assets and their unrealized losses are still on bank balance sheets. The Fed is aware that higher yields risk reigniting the bank crisis. Do not be surprised if the Fed or Treasury initiates some yield control if rates increase. As we said in the deficits section, neither the Government nor the economy can afford higher rates. For more, read our article- The Government Can’t Afford Higher for Longer.

Bottom Line:

QT is a short-term measure employed to normalize the Fed’s balance sheet. We have little doubt that when the time comes, the Fed will again aggressively buy bonds to reduce interest rates and limit the financial fallout of higher rates.

They will do whatever it takes when the time comes!

Summary

Like any other financial asset, bond yields trade up and down minute by minute. The media and investors tell stories explaining each move. But often, gyrations are simply a temporary imbalance of buyers and sellers. China, Japan, inflation, deficits, and QT are frightening stories and headlines. But as we share in this article and its predecessor, they should not worry bond bulls willing to endure short-term yield volatility for significant long-term reward.

No doubt, the bearish factors in this article are concerning. That said, we think they dwarf compared to the opportunity that bonds present. Currently, 10-year notes yield 3% more than the long-term trend economic growth rate and trend inflation. The graph shows the natural economic growth rate is likely around 1%. Earning 4% or more in a 1% economy is the best yield premium bond investors have been paid in well over 20 years. The real question bond holders need to ask themselves is, are the 60-year economic trends in the graph reversing higher? If yes, rethink bonds. If not, get them while they are cheap!

natural economic growth rates

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Four burning questions about the future of the $16.5B Novo-Catalent deal

To build or to buy? That’s a classic question for pharma boardrooms, and Novo Nordisk is going with both.
Beyond spending billions of dollars to expand…

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To build or to buy? That’s a classic question for pharma boardrooms, and Novo Nordisk is going with both.

Beyond spending billions of dollars to expand its own production capacity for its weight loss drugs, the Danish drugmaker said Monday it will pay $11 billion to acquire three manufacturing plants from Catalent. It’s part of a broader $16.5 billion deal with Novo Holdings, the investment arm of the pharma’s parent group, which agreed to acquire the contract manufacturer and take it private.

It’s a big deal for all parties, with potential ripple effects across the biotech ecosystem. Here’s a look at some of the most pressing questions to watch after Monday’s announcement.

Why did Novo do this?

Novo Holdings isn’t the most obvious buyer for Catalent, particularly after last year’s on-and-off M&A interest from the serial acquirer Danaher. But the deal could benefit both Novo Holdings and Novo Nordisk.

Novo Nordisk’s biggest challenge has been simply making enough of the weight loss drug Wegovy and diabetes therapy Ozempic. On last week’s earnings call, Novo Nordisk CEO Lars Fruergaard Jørgensen said the company isn’t constrained by capital in its efforts to boost manufacturing. Rather, the main challenge is the limited amount of capabilities out there, he said.

“Most pharmaceutical companies in the world would be shopping among the same manufacturers,” he said. “There’s not an unlimited amount of machinery and people to build it.”

While Novo was already one of Catalent’s major customers, the manufacturer has been hamstrung by its own balance sheet. With roughly $5 billion in debt on its books, it’s had to juggle paying down debt with sufficiently investing in its facilities. That’s been particularly challenging in keeping pace with soaring demand for GLP-1 drugs.

Novo, on the other hand, has the balance sheet to funnel as much money as needed into the plants in Italy, Belgium, and Indiana. It’s also struggled to make enough of its popular GLP-1 drugs to meet their soaring demand, with documented shortages of both Ozempic and Wegovy.

The impact won’t be immediate. The parties expect the deal to close near the end of 2024. Novo Nordisk said it expects the three new sites to “gradually increase Novo Nordisk’s filling capacity from 2026 and onwards.”

As for the rest of Catalent — nearly 50 other sites employing thousands of workers — Novo Holdings will take control. The group previously acquired Altasciences in 2021 and Ritedose in 2022, so the Catalent deal builds on a core investing interest in biopharma services, Novo Holdings CEO Kasim Kutay told Endpoints News.

Kasim Kutay

When asked about possible site closures or layoffs, Kutay said the team hasn’t thought about that.

“That’s not our track record. Our track record is to invest in quality businesses and help them grow,” he said. “There’s always stuff to do with any asset you own, but we haven’t bought this company to do some of the stuff you’re talking about.”

What does it mean for Catalent’s customers? 

Until the deal closes, Catalent will operate as a standalone business. After it closes, Novo Nordisk said it will honor its customer obligations at the three sites, a spokesperson said. But they didn’t answer a question about what happens when those contracts expire.

The wrinkle is the long-term future of the three plants that Novo Nordisk is paying for. Those sites don’t exclusively pump out Wegovy, but that could be the logical long-term aim for the Danish drugmaker.

The ideal scenario is that pricing and timelines remain the same for customers, said Nicole Paulk, CEO of the gene therapy startup Siren Biotechnology.

Nicole Paulk

“The name of the group that you’re going to send your check to is now going to be Novo Holdings instead of Catalent, but otherwise everything remains the same,” Paulk told Endpoints. “That’s the best-case scenario.”

In a worst case, Paulk said she feared the new owners could wind up closing sites or laying off Catalent groups. That could create some uncertainty for customers looking for a long-term manufacturing partner.

Are shareholders and regulators happy? 

The pandemic was a wild ride for Catalent’s stock, with shares surging from about $40 to $140 and then crashing back to earth. The $63.50 share price for the takeover is a happy ending depending on the investor.

On that point, the investing giant Elliott Investment Management is satisfied. Marc Steinberg, a partner at Elliott, called the agreement “an outstanding outcome” that “clearly maximizes value for Catalent stockholders” in a statement.

Elliott helped kick off a strategic review last August that culminated in the sale agreement. Compared to Catalent’s stock price before that review started, the deal pays a nearly 40% premium.

Alessandro Maselli

But this is hardly a victory lap for CEO Alessandro Maselli, who took over in July 2022 when Catalent’s stock price was north of $100. Novo’s takeover is a tacit acknowledgment that Maselli could never fully right the ship, as operational problems plagued the company throughout 2023 while it was limited by its debt.

Additional regulatory filings in the next few weeks could give insight into just how competitive the sale process was. William Blair analysts said they don’t expect a competing bidder “given the organic investments already being pursued at other leading CDMOs and the breadth and scale of Catalent’s operations.”

The Blair analysts also noted the companies likely “expect to spend some time educating relevant government agencies” about the deal, given the lengthy closing timeline. Given Novo Nordisk’s ascent — it’s now one of Europe’s most valuable companies — paired with the limited number of large contract manufacturers, antitrust regulators could be interested in taking a close look.

Are Catalent’s problems finally a thing of the past?

Catalent ran into a mix of financial and operational problems over the past year that played no small part in attracting the interest of an activist like Elliott.

Now with a deal in place, how quickly can Novo rectify those problems? Some of the challenges were driven by the demands of being a publicly traded company, like failing to meet investors’ revenue expectations or even filing earnings reports on time.

But Catalent also struggled with its business at times, with a range of manufacturing delays, inspection reports and occasionally writing down acquisitions that didn’t pan out. Novo’s deep pockets will go a long way to a turnaround, but only the future will tell if all these issues are fixed.

Kutay said his team is excited by the opportunity and was satisfied with the due diligence it did on the company.

“We believe we’re buying a strong company with a good management team and good prospects,” Kutay said. “If that wasn’t the case, I don’t think we’d be here.”

Amber Tong and Reynald Castañeda contributed reporting.

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Petrina Kamya, Ph.D., Head of AI Platforms at Insilico Medicine, presents at BIO CEO & Investor Conference

Petrina Kamya, PhD, Head of AI Platforms and President of Insilico Medicine Canada, will present at the BIO CEO & Investor Conference happening Feb….

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Petrina Kamya, PhD, Head of AI Platforms and President of Insilico Medicine Canada, will present at the BIO CEO & Investor Conference happening Feb. 26-27 at the New York Marriott Marquis in New York City. Dr. Kamya will speak as part of the panel “AI within Biopharma: Separating Value from Hype,” on Feb. 27, 1pm ET along with Michael Nally, CEO of Generate: Biomedicines and Liz Schwarzbach, PhD, CBO of BigHat Biosciences.

Credit: Insilico Medicine

Petrina Kamya, PhD, Head of AI Platforms and President of Insilico Medicine Canada, will present at the BIO CEO & Investor Conference happening Feb. 26-27 at the New York Marriott Marquis in New York City. Dr. Kamya will speak as part of the panel “AI within Biopharma: Separating Value from Hype,” on Feb. 27, 1pm ET along with Michael Nally, CEO of Generate: Biomedicines and Liz Schwarzbach, PhD, CBO of BigHat Biosciences.

The session will look at how the latest artificial intelligence (AI) tools – including generative AI and large language models – are currently being used to advance the discovery and design of new drugs, and which technologies are still in development. 

The BIO CEO & Investor Conference brings together over 1,000 attendees and more than 700 companies across industry and institutional investment to discuss the future investment landscape of biotechnology. Sessions focus on topics such as therapeutic advancements, market outlook, and policy priorities.

Insilico Medicine is a leading, clinical stage AI-driven drug discovery company that has raised over $400m in investments since it was founded in 2014. Dr. Kamya leads the development of the Company’s end-to-end generative AI platform, Pharma.AI from Insilico’s AI R&D Center in Montreal. Using modern machine learning techniques in the context of chemistry and biology, the platform has driven the discovery and design of 30+ new therapies, with five in clinical stages – for cancer, fibrosis, inflammatory bowel disease (IBD), and COVID-19. The Company’s lead drug, for the chronic, rare lung condition idiopathic pulmonary fibrosis, is the first AI-designed drug for an AI-discovered target to reach Phase II clinical trials with patients. Nine of the top 20 pharmaceutical companies have used Insilico’s AI platform to advance their programs, and the Company has a number of major strategic licensing deals around its AI-designed therapeutic assets, including with Sanofi, Exelixis and Menarini. 

 

About Insilico Medicine

Insilico Medicine, a global clinical stage biotechnology company powered by generative AI, is connecting biology, chemistry, and clinical trials analysis using next-generation AI systems. The company has developed AI platforms that utilize deep generative models, reinforcement learning, transformers, and other modern machine learning techniques for novel target discovery and the generation of novel molecular structures with desired properties. Insilico Medicine is developing breakthrough solutions to discover and develop innovative drugs for cancer, fibrosis, immunity, central nervous system diseases, infectious diseases, autoimmune diseases, and aging-related diseases. www.insilico.com 


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Another country is getting ready to launch a visa for digital nomads

Early reports are saying Japan will soon have a digital nomad visa for high-earning foreigners.

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Over the last decade, the explosion of remote work that came as a result of improved technology and the pandemic has allowed an increasing number of people to become digital nomads. 

When looked at more broadly as anyone not required to come into a fixed office but instead moves between different locations such as the home and the coffee shop, the latest estimate shows that there were more than 35 million such workers in the world by the end of 2023 while over half of those come from the United States.

Related: There is a new list of cities that are best for digital nomads

While remote work has also allowed many to move to cheaper places and travel around the world while still bringing in income, working outside of one's home country requires either dual citizenship or work authorization — the global shift toward remote work has pushed many countries to launch specific digital nomad visas to boost their economies and bring in new residents.

Japan is a very popular destination for U.S. tourists. 

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This popular vacation destination will soon have a nomad visa

Spain, Portugal, Indonesia, Malaysia, Costa Rica, Brazil, Latvia and Malta are some of the countries currently offering specific visas for foreigners who want to live there while bringing in income from abroad.

More Travel:

With the exception of a few, Asian countries generally have stricter immigration laws and were much slower to launch these types of visas that some of the countries with weaker economies had as far back as 2015. As first reported by the Japan Times, the country's Immigration Services Agency ended up making the leap toward a visa for those who can earn more than ¥10 million ($68,300 USD) with income from another country.

The Japanese government has not yet worked out the specifics of how long the visa will be valid for or how much it will cost — public comment on the proposal is being accepted throughout next week. 

That said, early reports say the visa will be shorter than the typical digital nomad option that allows foreigners to live in a country for several years. The visa will reportedly be valid for six months or slightly longer but still no more than a year — along with the ability to work, this allows some to stay beyond the 90-day tourist period typically afforded to those from countries with visa-free agreements.

'Not be given a residence card of residence certificate'

While one will be able to reapply for the visa after the time runs out, this can only be done by exiting the country and being away for six months before coming back again — becoming a permanent resident on the pathway to citizenship is an entirely different process with much more strict requirements.

"Those living in Japan with the digital nomad visa will not be given a residence card or a residence certificate, which provide access to certain government benefits," reports the news outlet. "The visa cannot be renewed and must be reapplied for, with this only possible six months after leaving the countr

The visa will reportedly start in March and also allow holders to bring their spouses and families with them. To start using the visa, holders will also need to purchase private health insurance from their home country while taxes on any money one earns will also need to be paid through one's home country.

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