Thu. Jan 20th, 2022


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Good morning. A few words to start with yesterday’s Covid piece, which expressed concern that the US might get the chance away from Austria this winter. Many readers have written to say that the most important difference is Austria’s greater population density. Well, maybe. But as my colleague John Burn-Murdoch points out, if higher population density explains the current outbreak, why did Austria have such a low infection rate until October? Its population did not suddenly become dense anymore. Second, some of the highest rates of Covid infection in the US are in low-density states like Alaska.

You will have noticed that neither I nor Ethan are epidemiologists, so now we’re moving back to familiar territory: the Federal Reserve and environmental, social and managerial, or ESG investments. Email us: robert.armstrong@ft.com and ethan.wu@ft.com.

RIP ‘transient’

Time to abandon “transient” Fed chairman Jay Powell Told the U.S. Senate on Tuesday. This terminological statement, coupled with an expression of support for faster weight loss, stifled the yield curve. The 10-year treasury note fell by 9 basis points as the two-year level remained the same. Expectations for rate hikes are also moving forward: markets dutifully priced in one by March 2022 on Tuesday. Shares were grumpy.

We wrote on the transient or permanent debate before. It would rage about whatever words Powell used. But given all the heat the term has generated, was the introduction of “perishable” in the lexicon a bad idea from the start?

Discussions on the term picked up in April, when core inflation exceeded 3 percent and Powell told reporters “these one-off increases in prices are likely to have only a temporary effect on inflation”. By May, the term had exploded in the public consciousness. Here are Google searches for “perishable” in 2021 (the index is relative to the highest point on the graph):

But the concept debuted long before that, back in May 2019. Powell used the term at the time to describe completely different circumstances. Inflation was about 1.6 percent, below the Fed’s target. Questions about the US Federal Reserve’s commitment to a symmetrical inflation target have become increasingly acute. Cautious about the skepticism, Powell told reporters:

“We suspect that some transient factors may be at work. . . And I point to things like portfolio management, service prices, clothing prices and other things. In addition, the shortened average measures of inflation have not fallen so much. Indeed, the Dallas average is at 2 percent. “

Sound familiar? The suspects are different – portfolio management instead of used cars – but the story is the same. “The (dis) inflation we are seeing is due to peculiarities that will disappear and leave the underlying price trends in place. In the meantime, look at the clipped average index. ”

From Powell’s perspective, the appeal of “transient” is clear. This sends the message that the Fed will not tighten policy in response to what it considers to be distinctive increases in inflation. This is a way to lower expectations for future rates, and to ensure the market a classic “Fed error” is not in the charts, without committing to a specific response to any data threshold.

But the draft invites misunderstanding, as Powell rightly said in his Senate testimony Tuesday:

“So I think the word transient has different meanings for different people. For many, it carries a [sense of] time, a sense of [being] short-lived. We tend to use it to mean that it will not leave a permanent mark in the form of higher inflation. I think this is probably a good time to withdraw that word and try to explain more clearly what we mean. ”

“Will not leave a permanent mark in the form of higher inflation” is clear enough: it means that, after the inflationary event is over, trend inflation will return to historically normal levels. That interpretation is consistent with how Powell used the term all along. But that usage is also compatible with an inflationary incident that has been going on for some time. But neither the market nor the public has ears for that level of subtlety. So in the end, the passing story was more confusing than enlightening.

To use the term as Powell did was a mistake, but a small one. Powell has shown a willingness to adapt at the moment data on dogma. Remember: both Powell’s patient response to inflation and his view that it will not hold can still be justified. If inflation moderates to 2-2.5 per cent as late as, for example, in the middle of next year, it will not feel transient. But from the point of view of history, an inflationary period that lasts just over a year – a real possibility – will indeed seem very transient. (Ethan Wu)

Glencore and Bluebell

Bluebell, a petty activist investor fund that has achieved some success by harassing people like Danone and GSK, want the commodities conglomerate Glencore to shut down its coal business into a separate entity. He believes a split will increase the value of the whole, as coal is an obstacle to the valuation of Glencore’s non-coal assets (which are mostly derived from the mining and trading of metals).

Bluebell argues that the coal business places a high cost of capital on the rest of the operation:

“Due to its coal business, Glencore is not an investable company for investors who place sustainability at the heart of their investment process. This is a major obstacle to greater investment in Glencore’s former coal business. . .

“A clear separation between carbonized and decarbonised assets is needed to increase shareholder value and remove the ‘coal discount’.”

Sustainability aside, Bluebell argues, coal is a dying business and the terminal value of Glencore’s coal assets is highly uncertain, another brake on the cost of capital.

Bluebell may be right that there is an ESG-driven coal rebate (though the point is not obvious: Glencore trades at similar multiples of earnings and at higher multiples of ebitda, like its coal-free counterparts Anglo American and Rio Tinto). It could also be good that the coal industry will wither even faster than the market expects.

What’s quite wrong is Bluebell’s view that Glencore’s tolling its coal assets will help fight global warming. Glencore is committed to winding up and closing down its coal assets over the next 30 years, but Bluebell says that:

“The simple concept that thermal coal should be part of Glencore’s portfolio until 2050 is, for us, as a company shareholder, both morally unacceptable and financially flawed.”

The necessary implication is that spinning the coal assets is morally better than not doing so. Why?

“The world is moving to net zero, and capital allocation is a key driver to accelerate this transition, as carbonized and decarbonised assets have started attracting many different pools of capital at significantly different costs. By separating businesses with different [carbon-dioxide] footprint, it will become possible to promote a global reallocation of capital to more sustainable companies, which in itself is a powerful force in driving decarbonisation. Conversely, by retaining a composite portfolio of low- and high-impact CO2 assets, it will become virtually impossible to use capital reallocation (ie via capital markets) as an engine of sustainability. ”

The idea here is that when the coal assets are in a separate entity, that entity will have a higher cost of capital (lower share price, higher yield effects) and therefore will have less money to invest in coal mining, leading to less coal burning. and less carbon in the air. It’s gibberish from front to back.

How much the hypothetical new entity will invest in coal assets also depends on the return on capital for the mining of coal, not just the cost of capital alone. Buy-off campaigns drive up those returns (assuming stable demand) by making coal assets cheaper to buy and limiting coal inventory. It is far from obvious that the balance between the cost of and return on mining capital will lead to less coal mining in the coming years.

Furthermore, there is no reason why it is not possible to reallocate capital from coal to non-coal within a composite portfolio. Bluebell complains that such cross-subsidization is economically inefficient, which is debatable, and in any case a separate issue.

Bluebell also tries on another argument:

“By transferring existing internal coal expertise to a separate entity – with the commitment to apply the same (and possibly stricter) coal ESG policy that is currently in place at Glencore group level – it would be possible to mine coal while remaining unchanged (and possibly improving) the company’s existing commitment to responsible ownership. ”

The argument is that when the coal business is separated, and all the shareholders who do not like to own coal sell to investors who are completely happy to own coal, the sustainability policies of the coal company will not change for the worse, and may even improve . These are bonkers.

Glencore shutting down its coal business is morally neutral and environmentally irrelevant, but it could be a good move financially.

A good read

Unhedged was shocked to learn from a colleague, who for some reason wanted to remain anonymous, that pop star Avril Lavigne died in 2003 and was replaced by a body double. Wild good.

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