What a difference a year makes! In September 2018 the US Federal Reserve and 15 other central banks across the globe raised interest rates in an attempt to wean markets off a multi-year rehab programme of monetary methadone. Fast forward to August 2019 and 21 central banks from Iceland to Peru were furiously cutting rates.
A global manufacturing slowdown and growing trade tensions have ostensibly prompted this monetary U-turn by multiple smaller central banks but be in no doubt the critical easing moves have been made by the ECB last week and the Federal Reserve yesterday. The decision of the latter to cut rates is striking as the US economy has been experiencing healthy growth, inflation and full employment. What’s not to like about that?
The unfortunate truth for the new Fed Chairman Jay Powell is that the position of the US dollar as the world’s reserve currency means US monetary authorities, unlike the occupant of the White House, must give consideration to the healthy functioning of global financial markets. It would appear that the Fed’s attempts to return interest rates to more normal levels have created problems elsewhere in the world. As an obvious example, higher interest rates in the US would attract buyers of the dollar which in turn causes the dollar to strengthen. That doesn’t seem a bad outcome for non-US companies whose goods and services would become cheaper relative to US-based competitors.
However, it has not panned out that way. Higher interest rates are good for depositors but not so for borrowers who have loans priced in USD. That challenge is further exacerbated if the borrower’s cash flow to service the loans is earned in a weakening local currency. Bluntly, the attempt to return to more normal higher interest rates has revealed a problem of excess leverage in the financial system.
We have touched upon a number of quiet developments in this column in recent weeks which have now crept onto the front pages of financial media. For Irish businesses, these developments could now start impacting the behaviours of service providers and customers. Let’s start with the murky world of financial plumbing.
We had written last week about the slightly bizarre possibility of a “dollar shortage”. Sure enough, over the last three days market observers have been grappling with unusual happenings in a very technical part of the intra-bank funding market; the Repo market. On a daily basis(as a basic guide) banks swap high-quality collateral like US Treasury Bonds for US dollar cash to meet overnight obligations. All works smoothly until it doesn’t, usually a shortage of actual cash or confidence – think 2008. What has commentators worried and confused this time is that the Federal Reserve has been required to pump additional cash into this niche market to avoid a bank, or banks, being unable to meet its obligations overnight. The Fed has not had to intervene in the repo market like this since…. 2008. The sums are not small. In the early hours of Tuesday morning, the Fed had to come to the rescue to the tune of $53 billion. The next day it was $75 billion, and the next day…
This could be a temporary blip in the money markets but we don’t know which banks needed the cash. There is a suspicion it could be Asian banks whose clients are struggling under a $3.7 trillion mountain of debt which is dollar-denominated. For Irish corporates exporting goods and services to Asian markets, it is probably worth keeping a watch on any significant exposures to single banking entities or corporates. This may sound Casandra-ish but when confidence begins to waver things can develop quite suddenly and not in a good way.
Only a few weeks ago we were writing about our concerns on the WeWork IPO proposition. It now turns out the IPO has been delayed after initial valuations of over $40 billion circled the drain at $10 billion for a few days before the bankers gave up. You might think an IPO delay is not too bad an outcome but the knock-on effect has been worrying for the entire WeWork franchise. The company’s bonds(debts) have been weakening significantly subsequent to the pulling of the IPO financing. This, in turn, has raised concerns about the actual WeWork business model. Recall that this “technology” property company has $47 billion worth of lease commitments serviced by a not-so-certain estimated revenue base of $3 billion. Just this week there are reports of property deals in London falling through as WeWork was the key tenant in the buildings. Now consider WeWork is the largest private occupier of office space on Manhattan island and the increasing speculation as to whether WeWork will actually be working by 2021!
A major dislocation in the office rental market could spell trouble for the global commercial real estate sector but could be helpful for startups struggling with office rental rates. Property companies with large debt obligations can suddenly be quite open to negotiation.
Ultimately, the level of interest rates or rents is not what kills a franchise. It’s all about the leverage employed in the business. The Fed knows that too.
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