FIG Topics of Interest

 

03/08/18

Big oil and big corn are touting opposing studies released this week on proposed biofuels policy reforms under consideration by the Trump administration, part of an ongoing clash between the two sides over the future of the program.
Valero Energy Corp, a major oil refiner, funded a study by Charles River Associates that supports placing a cap on the price of biofuel blending credits under the U.S. Renewable Fuel Standard (RFS) - a change meant to help refiners that complain the RFS now costs them a fortune.
A rival report from Iowa State University, also released this week, said such a cap on credits would backfire by eroding U.S. demand for corn-based ethanol and potentially lowering corn prices, already under pressure from a supply glut. The corn industry did not directly fund the Iowa State study, but does provide funding to the university.
The studies are meant to inform the administration’s deliberations on how, and if, to reform the RFS - which has become a major point of tension between two of President Donald Trump’s most important constituencies.
The RFS requires oil refiners to blend increasing amounts of biofuels, mainly corn-based ethanol, into the fuel supply each year, or buy the renewable fuel credits, called RINs, from other companies that do the blending.
The regulation was introduced during the administration of President George W. Bush to help farmers, cut petroleum imports, and improve air quality. But a surge in the price of RINs in recent years has upset merchant refiners who say the policy now costs them hundreds of millions of dollars a year.
Trump waded deeply into the debate last week, urging representatives of both sides to accept a compromise deal that caps prices for the credits while also removing seasonal limits on high-ethanol blend gasolines to expand the biofuels market.
A cap would control costs for small refiners and help them stay afloat, said Brendan Williams, vice president of government relations for refining company PBF Energy (PBF.N).
The biofuels industry likes the idea of expanding high-ethanol blend gasoline sales, but has pushed back on the idea of a cap. “The RFS is a well-designed program,” said Brooke Coleman, head of the Advanced Biofuels Business Council. “Part of the whole mechanism working is that the price of RINs may go up, and so you should go long on biofuels.”
“It’s a strategy to kill the RFS and to kill the economic incentive to blend,” said Coleman, referring to a 10-cent cap.

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03/07/18

“I can’t believe this is happening,” Michael Purves, Weeden & Co.’s chief global strategist, said by phone. “I wrote up Cohn’s departure this morning as a real risk to consider. I thought it’s like a 35 percent probability event. I was just amazed that Trump is letting this happen.”
“Of all the Trump administration resignations, this will be the one most meaningful for markets,” said Michael O’Rourke, chief market strategist at JonesTrading Institutional Services. “Cohn was the administration official financial markets had the most confidence in. This opens the environment up to whole new wave of uncertainty. The likelihood of a trade war just jumped dramatically.”
“A lot of people saw him as a calming influence to the Trump administration,” said Nick Twidale, Sydney-based chief operating officer at Rakuten Securities’ Australian unit. “Now he’s gone, there’s that perception that maybe they’re letting loose the hardline aspects of the Trump administration to go even harder on protectionism.”
“Policy uncertainty has underpinned a lot of the market’s recent volatility,” Stephen Wood, chief market strategist for North America at Russell Investments in New York, said by phone. “This speaks to the instability. He’s an advocate for free trade policy so there would be expectation that protectionist voices would be more representative in the administration.”
“Cohn’s huge accomplishment was tax reform, which responded to low corporate taxes abroad by bringing the U.S. corporate sector back to a competitive position,” said Barry Bannister, chief equity strategist at Stifel Nicolaus & Co. “Almost all nations had been under-cutting the U.S. on corporate tax rates and export subsidies such as refunding sales taxes at the point of export, which is prevalent abroad.”

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03/06/18

The value of multifamily housing starts spiked 39% in January, with 11 projects valued at $100 million or more breaking ground as apartment and condominium construction showed fresh legs after three straight months of declines to close 2017. As a group, the commercial construction categories excluding multifamily - office, industrial, retail and hospitality projects - fell 15% in January. The value of new office construction starts declined 31% after a sharp 44% increase in December. Hotel construction dropped 13% in January after a modest 4% gain in December. 
The supply wave has not crested in the U.S. multifamily sector, with CoStar’s forecast calling for delivery of approximately 500,000 units over the next two years, with much of the new development concentrated in large urban projects near CBD office buildings and retail. While office construction starts closed out 2017 below their historical average for the 10th consecutive year, office deliveries are expected to reach a cyclical high this year, with CoStar forecasting that the new supply will cause the U.S. office vacancy rate to begin ticking up as completed construction finally begins to outpace demand. 
Over 225 million square feet of industrial properties delivered in 2017, the highest recorded in over 10 years, and of January 2018, over 230 million square of industrial space had broken ground in the last year, much of speculative development. The level of retail construction remained well below historical average, with just over 60 million square feet under construction as of December compared with last cycle’s peak of nearly 170 million square feet. 
Despite slowing conditions in almost all sectors besides multifamily, optimism abounds in the construction and design industries. The "optimism quotient" in Wells Fargo's 2017 Construction Industry Forecast released this week was 133, a 10-point increase over last year and the highest reading for the index since the late 1990s. 
Total nonresidential construction, including commercial, institutional and public works projects, remained flat, edging up 1% in January to $240.8 billion despite a 149% jump in entertainment-related projects, including the groundbreaking for the $1.3 billion domed stadium in Las Vegas that will be the new home for the Oakland Raiders, slated for occupancy prior to the 2020 NFL season. 

Click here to download a pdf of this article, Missile.pdf
 
 

03/05/18

The president’s decision to impose 25 percent tariffs on imported steel and 10 percent on aluminum raises the probability his administration will take a hawkish approach to other trade issues, such as talks to overhaul Nafta, Goldman Sachs economist Alec Phillips said in a research note.
Negotiators from the U.S., Canada and Mexico have been hunkered down in Mexico City for more than a week in the seventh round of talks to work out an update to Nafta.

But talks have been bogged down over U.S. proposals designed to reduce its trade deficit, such as tighter content requirements on cars. Goldman sees the stalemate continuing, along with a “good chance” Trump will at some point follow through on his threat to withdraw from the pact. The talks look set to extend beyond a goal of end-March.
The next shoe to drop could be an investigation by Trump’s top trade negotiator, Robert Lighthizer, into whether China is flouting U.S. intellectual-property rights. Goldman expects the administration to impose restrictions on Chinese investment as a result of the so-called 301 probe, and may even go further. Trump has said he wants to impose a big “fine” as part of that investigation.
To be sure, it’s not the first time the U.S. has cracked down on foreign steel. Ronald Reagan and George W. Bush both imposed barriers on imports, but the U.S. steel industry has continued to struggle in the decades since. “We’ve been here before,” said Robert Holleyman, a partner at law firm Crowell and Moring LLP who served as deputy U.S. trade representative in the Obama administration.
Tariffs probably won’t address China’s “massive excess capacity” in steel, the fundamental problem for U.S. producers, since Chinese steel exports account for a small share of U.S. consumption, Holleyman said.
With his move on steel, Trump is invoking a seldom-used clause of a 1962 law that gives him the authority to curb imports if they undermine national security. World Trade Organization rules allow members to restrict trade that imperil their “essential security interests.” Other countries are expected to challenge the tariffs at the Geneva-based trade body, in what will be the first test of the security provision since the WTO was born in 1995, said Gary Hufbauer, a trade expert at the Peterson Institute of International Economics in Washington.

WTO Director-General Roberto Azevedo on Friday said there’s a “real” risk of worsening disputes because of the tariffs, and that a trade war doesn’t suit any nation’s interests. “The potential for escalation is real, as we have seen from the initial responses of others,” Azevedo said. “The WTO is clearly concerned at the announcement of U.S. plans.”
Hufbauer thinks the U.S. would win a WTO case, though. And even before then, other governments will be emboldened to impose their own barriers in the name of national security, he said. “That really opens a Pandora’s box,” said Hufbauer.

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02/23/18

"All told, we are seeing some signs of a slowdown in the retail market," said McCullough, noting that retail absorption totaled about 69 million square feet for 2017, down about 30% from 2016 and 2015 levels, with developers expecting to deliver roughly 80 million square feet of new retail space in 2018 as demand from retail tenants begins to soften. "Given the slowdown in demand and some uptick in supply, we might anticipate the national retail vacancy rate, which went flat in 2017, to start to rise modestly in 2018," McCullough said.

One sign of the softening market conditions is a moderate rise in vacancies and flat-lining of rental rate growth in recent quarters at the country's top located and most productive Class A malls, urban luxury centers and shopping centers. These properties have consistently logged the highest location quality scores, as ranked by CoStar’s proprietary formula measuring the combined effects of demographics, density of surrounding commercial property and market competition on individual retail centers.

While retailers are readily absorbing some new supply entering the market, especially spaces of 20,000 square feet and below, larger boxes in certain centers that are ranked in the top 10 percentiles of location quality are in many cases taking longer to lease up, reflecting broader weakness among U.S. power center tenants. 

Meanwhile, at the opposite end of the quality spectrum, the number of "zombie" power centers with vacancy rates of 40% or more has increased 60% since 2016, due to a spike in store closures by Kmart, Toys R Us and other big-box retailers and grocers. The closures and bankruptcy filings are mounting weekly and likely will not abate any time soon. Toys R Us plans to close another 200 stores and lay off corporate personnel, in addition to 170 previously announced store closures, the Wall Street Journal reported Thursday. On Wednesday, Northeast supermarket chain Tops Markets LLC filed for Chapter 11 bankruptcy protection.

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02/20/18

“The meaning of the word ‘further’ was far from clear,” said Roberto Perli, partner at Cornerstone Macro LLC in Washington. “Maybe it was meant to convey a continued string of hikes over time? Who knows? I hope the minutes clarify what they meant.”

At Chair Janet Yellen’s last meeting Jan. 30-31, the central bank pledged twice to make “further gradual adjustments” in interest rates as opposed to just “gradual adjustments” at the prior gathering. While the language was consistent with adding more emphasis to the plan for rate hikes, the minutes of the closed-door meeting, due Wednesday, will probably give details on what message officials wanted to send with the wording tweak.

One possibility is that it was an indication the Federal Open Market Committee was debating raising interest rates by more than the three moves officials had penciled in for 2018. Another idea is that policy makers may have discussed increasing their estimate of the neutral interest rate -- a theoretical level that neither speeds up nor slows down the economy -- in light of new U.S. fiscal stimulus.

Click here to download a pdf of this article, Missile.pdf
 
 

02/16/18

The U.S. tax overhaul package is freeing up cash for companies and the Federal Reserve is hiking rates, but chief financial officers are still eager to borrow, UBS strategists wrote this week. The Swiss bank and Wells Fargo both expect businesses to sell as much U.S. investment-grade and junk bond debt this year as they did in 2017, if not more, in part to fund an expected uptick in mergers and acquisitions. 
If blue-chip corporate bond issuance sets another record, it would be the fifth year in a row that it reached a new high. The forecasts imply that the benefits from tax cuts are more likely to flow to shareholders than bond investors, and that for money managers, buying U.S. company debt may not be the sure thing that many previously thought. 

Click here to download a pdf of this article, Missile.pdf
 
 

02/15/18

Lewis Alexander, chief economist at Nomura Securities International Inc., and Greg Daco, Oxford Economics’ chief U.S. economist, were among those who now see four Fed rate hikes in 2018 instead of three, according to a Bloomberg survey of 29 respondents conducted Feb. 12-14. That brought the survey’s median estimate for the upper bound of the central bank’s federal funds rate target to 2.5 percent by year-end. It is currently at 1.5 percent. 

“Stronger growth and higher inflation would increase the odds of four Fed rate hikes in 2018,” Daco said in his survey comments. He added that the recent market strains won’t prevent a rate increase at the central bank’s next policy-making meeting on March 20-21.

In their last quarterly projection in December, Fed officials penciled in three rate hikes for this year, according to the median forecast in their so-called dot plot. They tacitly reiterated that view at their Jan. 30-31 meeting, when they said they expected “further gradual increases in the federal funds rate.”

Economists are getting more upbeat about economic growth this year and next, according to the survey. They see gross domestic product expanding 2.9 percent in 2018 and 2.5 percent next year. GDP has averaged a 2.2 percent advance since the expansion began in mid-2009.

“Too much of a good thing is too much,” Joel Naroff, president of Naroff Economic Advisors Inc., said in his survey response. “The tax cuts, spending increases and potentially infrastructure package are likely to accelerate inflation and cause the Fed to raise rates higher and faster than expected.”

Click here to download a pdf of this article, Missile.pdf
 
 

02/15/18

Lewis Alexander, chief economist at Nomura Securities International Inc., and Greg Daco, Oxford Economics’ chief U.S. economist, were among those who now see four Fed rate hikes in 2018 instead of three, according to a Bloomberg survey of 29 respondents conducted Feb. 12-14. That brought the survey’s median estimate for the upper bound of the central bank’s federal funds rate target to 2.5 percent by year-end. It is currently at 1.5 percent. 

“Stronger growth and higher inflation would increase the odds of four Fed rate hikes in 2018,” Daco said in his survey comments. He added that the recent market strains won’t prevent a rate increase at the central bank’s next policy-making meeting on March 20-21.

In their last quarterly projection in December, Fed officials penciled in three rate hikes for this year, according to the median forecast in their so-called dot plot. They tacitly reiterated that view at their Jan. 30-31 meeting, when they said they expected “further gradual increases in the federal funds rate.”

Economists are getting more upbeat about economic growth this year and next, according to the survey. They see gross domestic product expanding 2.9 percent in 2018 and 2.5 percent next year. GDP has averaged a 2.2 percent advance since the expansion began in mid-2009.

“Too much of a good thing is too much,” Joel Naroff, president of Naroff Economic Advisors Inc., said in his survey response. “The tax cuts, spending increases and potentially infrastructure package are likely to accelerate inflation and cause the Fed to raise rates higher and faster than expected.”

Click here to download a pdf of this article, Missile.pdf
 
 

02/14/18

“Carried interest was a key litmus test of whether the bill can be called tax reform, and it failed,” Steven Rosenthal, a senior fellow at the Urban-Brookings Tax Policy Center in Washington, said of the tax overhaul passed in December. “This legislation was a Swiss cheese.”
Under pressure from industry lobbyists and exploiting a split among White House advisers, the Republican Congress in December failed to fulfill Trump’s promise to end the tax windfall enjoyed by money managers. And lawmakers may have stumbled in trying to narrow their tax advantage, writing the new carried-interest rule in a way that provides firms an easy escape.

The rule requires hedge funds and private-equity players to hold investments for at least three years to get the lower capital gains rate, rather than one year under the old law. Otherwise, they must pay the higher income tax rate.

The rule, however, exempts carried interest from the longer holding period when it’s paid to a corporation rather than an individual. To the surprise of legal and accounting experts, the law didn’t specify that it applied solely to regular corporations, whose income is subject to double taxation.

Hedge funds are preparing to exploit the wording: Managers are betting that by simply putting their carried interest in a single-member LLC -- and then electing to have it treated as an S corporation -- the profit will qualify for the exemption from the three-year holding period and be taxed at the lower rate. The maneuver by money managers contributed to a 19 percent jump in the number of LLCs incorporated during December in Delaware.

“It’s a total end-run around the statute,” said Anthony Tuths, a tax principal in the alternative investment unit of KPMG’s New York office. The Delaware filings “spiked through the roof because all these fund managers set up single-member LLCs,” said Tuths, adding that he doesn’t endorse the strategy because the government could still close the loophole.

Click here to download a pdf of this article, Missile.pdf