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Good morning. Nice rally in stocks yesterday, for no apparent reason. We’re sticking with the commonsense view that market is going to stay messy until we have a better guess where the Federal Reserve is going to stop, so we’re buckling up for more of this in the coming months. Email us if you have a better idea: email@example.com and firstname.lastname@example.org.
Clearly, we should have written about the European debt proto-crisis last week, but we were too captivated by the Fed to catch up on the situation properly.
While we dithered, the European Central Bank seems to have scared sellers of European peripheral bonds into backing off, buying some time to come up with a structural solution to this problem:
That’s the spread between Italian and German 10-year bonds, which began widening as soon as it became clear that inflation would force the ECB to follow the Fed in raising interest rates. At the right side, you can see how the ECB’s emergency meeting last Wednesday, and the promises of action issued afterwards, reversed the widening, for now.
Recall the basic problem. Italy — which is emblematic of many peripheral eurozone countries from Spain to Greece — has even more debt than it did when it slipped into a crisis 10 years ago. The maths is really nasty now. Italy’s debt is 150 per cent of gross domestic product. Its 10-year bonds, for example, yield 3.7 per cent. Of course it will have sold debt at lower yields than that, but as old debt rolls over, the cost will rise. GDP, on the other hand, is not going to grow at anywhere near 5.5 per cent (3.7 per cent x 150 per cent). So the Italian debt burden is set to grow steadily bigger relative to GDP.
This causes problems. Higher interest rates slow growth in general. Households own quite a lot of the debt, creating negative wealth effects. Banks own a lot too, so as the bonds lose value, their balance sheets weaken and they can’t make as many loans. Then there is the possibility of portfolio contagion bringing other European asset prices down. The debt wobbles could also push the euro even lower, and therefore push the dollar even higher — which is an automatic tightener of financial conditions globally.
This is all quite bad. And then there is the very remote but not unthinkable political follow-on: life within the eurozone becomes so unpleasant for Italians that the country decides to leave the common currency.
The ECB really does not want any of this stuff to happen. Hence its commitment to some kind of bond-buying programme, or “anti-fragmentation instrument”, that would compress Italian (or other peripheral) debt spreads. The details will come next month.
The good news is that the ECB governing council seems to be on the same page, and they are getting after the problem early. As rapid and unsettling as the rise in spreads has been, their absolute level was higher as recently as 2018-19, as the bank’s bond-buying programmes tailed off. Same chart, going further back:
The bad news is that the job of depressing the spreads is made complicated by inflation. It is bonkers to buy bonds and raise rates at the same time. In monetary policy terms, the two have opposite effects. So the ECB plan will have to involve some form of “sterilisation” to keep the peripheral purchases neutral to the money supply. Presumably this will mean sales of some other flavour of euro bond, or some sort of term deposit mechanism to sop up the proceeds from the bond purchases (it may also be that anti-fragmentation means that the ECB will have to enact more rate increases than it would have otherwise).
This is all a big experiment. As Eric Lonergan of M&G summed up in Monday’s FT:
Sovereign spread targeting by a central bank has never been done before. The outline of a programme would involve creating a reference basket of “safe” European sovereign bonds from core eurozone countries such as Germany and determining an acceptable spread for each market. The ECB would then commit to enforcing a cap on these spreads . . .
We need to be clear about the risks. In extremis, the ECB becomes the market-maker for [Italian] or other bonds. Liquidity could disappear. How will Italy issue debt in the primary market, and at what price? Can the arrangements be gamed by market participants? How will the ECB exit?
The ECB is in terra incognita, and if things go wrong, the world economy is going to receive yet another nasty growth shock.
How much money will the ECB spend buying peripheral bonds, and will it be enough? Frederik Ducrozet of Pictet has estimated that €10bn a month could be put to work initially, raised by redemptions of assets bought under the Pandemic Emergency Purchase Programme. But, he points out, twice that amount of Italian debt needs to be rolled over through the rest of this year. Pepp reinvestment “probably falls short of the support needed in case of severe fragmentation and protracted market dislocations”. The ECB may have to go further.
So this could get expensive. But there is the possibility of a significant long-term upside. The original sin of the eurozone is common currency and monetary policy without a central fiscal policy, like the one enjoyed by the US. Anti-fragmentation could be a step in that direction. Here is George Saravelos of Deutsche Bank:
The [proposed anti-fragmentation] tool increases implicit fiscal pooling and establishes a de facto eurobond. A peripheral backstop can theoretically be conceived as a put option on [Italian bonds] and a call option on [German] Bunds thereby creating a more stable GDP-weighted risk-free rate. Assuming the operations are sterilised, the eurosystem will absorb peripheral risk on its balance sheet in exchange for short-dated risk-free liabilities (most likely term deposits) thereby increasing fiscal pooling. An investable [European bond] basket improves European yield. Consider that the Euro-US 10-year interest rate differential is at an eight-year high outside of Covid.
Europe has proven in the past that, under duress, it will do what it takes to hold together its fragile and faulted monetary-financial-political structure. If it does so again this time, it might also end up making some structural improvement.
Given this, it might be tempting to try the Jon Corzine memorial trade, and bet that spreads will compress before you get margin called. Not a stupid bet but, as Corzine discovered, a tricky one to time.
The champ, at rest.
Nato is to agree an overhaul of its plans to offer better protection to the alliance’s eastern flank, tearing up a model that could have meant relinquishing Baltic states and then attempting to recapture them in the event of a Russian invasion.
Jens Stoltenberg, Nato secretary-general, told the Financial Times that the military blueprint, to be agreed at an annual leaders’ summit that begins in Madrid tomorrow, would drastically upgrade the alliance’s eastern defences, shifting focus from deterrence to a full defence of allied territory.
Estonia’s prime minister has claimed that under the current doctrine, Baltic states would be “wiped off the map” by a Russian assault before Nato attempted a counter-attack to liberate them after 180 days.
The alliance will “significantly reinforce” its defences in eastern Europe, Stoltenberg said, pledging that Russia would not be able to capture the Estonian capital Tallinn “just as they have not been able to seize the city of Kirkenes in northern Norway or West Berlin during the cold war”.
Military developments: Russian missiles struck residential buildings in central Kyiv yesterday. Ukraine’s retreat from the eastern city of Severodonetsk was a “tactical” move to avoid a repeat of the siege in Mariupol, the country’s military intelligence chief said.
Energy politics: G7 leaders meeting in the Bavarian Alps are seeking a deal to impose a “price cap” on Russian oil to curb Moscow’s ability to finance its war.
Thanks for reading FirstFT Europe/Africa. To start your week, here’s the rest of the day’s news. — Jennifer
1. EY valued NSO Group at $2.3bn The Big Four accounting firm valued the secretive Israeli spyware company at $2.3bn, months before the maker of the Pegasus cyberweapon needed emergency bailout funding. By contrast, Berkeley Research Group, which represents NSO’s private equity owners, said this year that the company’s equity was “valueless”.
2. BIS: leading economies at risk of high-inflation trap The Bank for International Settlements warned yesterday that major economies were close to “tipping” into a high-inflation world in which rapid price rises dominate daily life and are difficult to quell, and urged central banks not to be shy about inflicting short-term pain and even recessions to prevent it.
3. RWE: UK windfall tax could risk £15bn in renewables The head of one of the country’s largest power producers has warned that Germany’s biggest utility will reconsider £15bn of investment in the UK’s renewable energy sector if the country imposes a windfall tax on electricity generators.
4. UBS courts US investment heavyweights The Swiss lender, the world’s biggest wealth manager, has begun courting investment houses to become top shareholders as it tries to improve its market value to be closer aligned with Wall Street peers and project an image as a global bank.
5. UK Treasury takes stake in sex party planner The British taxpayer has become a shareholder in Killing Kittens, known for its exclusive and hedonistic events, under the Future Fund, a scheme set up by Chancellor Rishi Sunak to support innovative firms during the pandemic under which loans are converted into equity.
UK lawyers on strike Members of the Criminal Bar Association begin a walkout in an escalating dispute with the government over funding, which is expected to cause widespread disruption to hearings across England and Wales.
UK changes N Ireland trading regime MPs will have their first vote on Boris Johnson’s legislation to unilaterally rip up parts of Northern Ireland’s post-Brexit trading arrangements, despite fierce criticism from Brussels.
Economic indicators The annual European Central Bank Forum on Central Banking begins in Sintra, Portugal. In the US, durable goods orders may show whether inflation, rising interest rates and economic uncertainty weighed on demand in May. (FT, WSJ)
UN Ocean Conference The week-long conference on ocean conservation and sustainability starts and is co-hosted by Kenya and Portugal.
Companies developments Nike posts fourth-quarter results. Disney’s board meets for two days less than a week after giving under-fire chief executive Bob Chapek a vote of confidence.
Wimbledon begins The tennis tournament starts at the All England Lawn Tennis and Croquet Club in south-west London without the men’s top player or women’s reigning champion. Daniil Medvedev is ineligible after a ban on Russian players, while Ash Barty has retired. “Retiring aged 25 seems like filing for divorce while on honeymoon. But Barty’s decision reveals various truths,” writes Henry Mance.
Grim times lie ahead for UK The country is in the throes of the kind of labour unrest not seen for decades. The explanation for it is clear. Unanticipated inflation delivers losses everybody wants to recoup. This triggers social conflict, writes Martin Wolf. Yet if inflation is bad, so is the cure.
The road to rolling back Roe vs Wade As the Supreme Court overturns the landmark 1973 ruling enshrining the constitutional right to abortion, Lyz Lenz documents the rise of the Christian right and how it reached this historic moment. In response to the ruling, Democratic lawmakers are stepping up efforts to establish “sanctuary states” for reproductive rights.
Crypto and meme corporate bonds follow their own path The crash of some of the flagbearers of the equity bubble has been painful for investors. Less noticed are the losses of their bonds. Such gaps illuminate differences in the ownership and returns for stocks versus bonds, writes Ellen Carr at Barksdale Investment Management.
How the beauty industry left tortoise-like Revlon trailing Once a behemoth of the beauty industry, Revlon has been sidelined by modern influencer- and social media-driven make-up brands. The 90-year-old group’s bankruptcy filing reveals how competitive and fast-paced the sector has become.
There’s no such thing as an accidental plagiarist The acclaimed Australian novelist John Hughes claims that many of the 58 instances of plagiarism in his new book were by accident. Everyone steals when they write, but where does “good” theft end and clumsy rip-off start?
Whether you are looking for a book on urbanism, a literary thriller, a tome on the royal family or something else unexpected, you will want to take a look at these must-read titles recommended by FT writers and editors.
Anyone who wants to better understand the costly economic and political externalities that come with cheap food should spend some time in America’s Midwestern farm country. I did last week, driving from Wisconsin to Missouri through hundreds of miles of corn and soyabeans, the vast majority of which is grown not as food but as feed for cattle.
It was easy to find fast food and red meat in the small towns I passed, but it was often tough to find a decent supermarket with fresh fruits and vegetables. What a terrible irony that some of the richest farmland in America is often where you are most likely to find a “food desert”, or a place where it is challenging to source the components of a healthy diet.
Nearly a century on from the Great Depression, we still farm as we did then, trying to produce cheap calories for growing numbers of hungry people — and using huge amounts of fossil fuels — rather than providing better nutrition for an overfed yet undernourished population in ways that might support the planet and local communities.
Consumers have become used to cheap food. But it’s a model that makes little sense environmentally, and has led to tremendous consolidation on the production side.
Consider that in the middle of the biggest commodity price spike since the 1970s, some farmers are still struggling to stay in the black. Texas A&M University research shows that two out of three rice farmers will lose money this year, since input costs including fuel and fertiliser are rising even faster than commodity prices. Corn and soyabean producers will make money, but not as much as you’d think.
As Joe Outlaw, a professor at Texas A&M, put it in his testimony on the topic to the House Agricultural Subcommittee, consumer inflation may be 8.5 per cent but farmers have been hit with price increases at double that rate on seed. For other inputs, inflation is even higher. Herbicide is up 64 per cent from 2021 to 2022, and nitrogen fertiliser, perhaps the most important input of all, is up a whopping 133 per cent. Corn, meanwhile, is up only 4.84 per cent per bushel, and soyabeans are up a little over 7 per cent year on year.
Farmers have tried to hedge and hoard to account for these spikes, but they are outgunned by large, highly concentrated companies that control much of the agriculture supply chain. As Outlaw explained: “Simply put, the input suppliers would not lock in a price until the producers [meaning farmers] agreed to take delivery.”
The result is that many farmers, particularly small and medium-sized ones, will scale back on inputs this planting season, which will in turn hurt their future harvest. Grain trading giants such as Cargill are getting rich, as are many multinational energy companies. But growers themselves are barely in the black.
All of this speaks to a model that no longer works. Farming in America has been about cheap food for nearly a century. The New Deal encouraged the production of massive amounts of subsidised cereal grains to feed an influx of urban dwellers. The Reagan revolution encouraged further consolidation — as an illustration, consider that four companies control up to 85 per cent of the meat market.
Democratic President Bill Clinton then passed the “Freedom to Farm” act, which eliminated any government management of supply and demand. This is one reason farmers were dumping milk after the pandemic; overproduction encourages boom and bust cycles. It also makes it difficult to get food inflation under control now. While the US has strategic petroleum reserves, it has no grain reserves for domestic buyers despite being one of the world’s largest producers.
The “pile it high, sell it cheap” paradigm assumes that simply driving down prices will create a healthy market. But it comes with obvious costs for the planet, our health, and in some parts of the country, for politics. One would think that a state like Missouri, for example, would be fertile ground for Democrats campaigning on a message of corporate greed. In fact, the state voted for Donald Trump in the last election — in part because the failed industrial farming model hasn’t been replaced by much else, creating a disenchanted population that’s ripe for the former president’s dog whistles and his brand of populism, with its empty promises of help for the white working class.
Plenty of neoliberal economists might shrug at all this and note that farmers make up less than 2 per cent of the labour force (the agricultural sector as a whole is slightly over 10 per cent). They might even shrug at the fate of a state like Missouri, since they tend to think about overall numbers, not individual people in so-called flyover states. But in America’s electoral college system, states like this still matter — a lot. Taken together, they can make the difference between winning or losing.
So, what’s to be done? The Biden administration is correct to go after concentration in agriculture and energy, as in other industries. Indeed, the discrepancy between input costs and raw commodity prices makes me think that the White House has a point about corporate price gouging. If the commerce department gets its way, more rural broadband would help too. But ultimately, we are going to have to rethink the entire way we farm in America. Like so much of our economic system, it was built for a different era.
The Chinese memory chip producer Yangtze Memory Technologies plans to bring online a second plant in its home city of Wuhan as early as the end of this year, sources familiar with the matter say, in a move that could further close the company’s technology and output gap with global leaders such as Samsung of South Korea and Micron Technology of the US.
The company, also known as YMTC, needs to expand production after a growth spurt that put it on the world’s semiconductor map and delivered a notable success in Beijing’s attempt to reduce China’s reliance on imported chips.
Its original plant has been running near capacity and churned out 100,000 wafers a month at the end of 2021, two people told Nikkei Asia.
YMTC held a global market share of nearly 5 per cent last year, according to analyst and industry estimates. It has become the world’s sixth-largest Nand flash memory maker behind Samsung, SK Hynix, Kioxia, Western Digital and Micron, and the only one from China.
About 40 per cent of its output at present is 128-layer 3D Nand flash memory, the most advanced produced so far by a Chinese chipmaker. But that is one or two generations behind global leaders Samsung, SK Hynix and Micron. The rest of YMTC’s output is of older 64-layer 3D Nand flash memory.
This article is from Nikkei Asia, a global publication with a uniquely Asian perspective on politics, the economy, business and international affairs. Our own correspondents and outside commentators from around the world share their views on Asia, while our Asia300 section provides in-depth coverage of 300 of the biggest and fastest-growing listed companies from 11 economies outside Japan.
The new plant would first build mainly 128-layer flash memory and could later shift to even more cutting-edge chips, such as 196-layer or 232-layer 3D Nand flash memory, assuming development goes smoothly in 2023 and 2024.
Apple has been testing YMTC’s flash memory products since last year and could place its first order for “limited quantities” as soon as this year, two people familiar with the matter told Nikkei Asia. The US tech giant has been talking with the Chinese chipmaker since 2018 in hopes of finding a cost-effective source of storage components.
Securing a deal with Apple would be a milestone, highlighting the quality of Yangtze Memory’s chips, industry executives say. Apple’s Chinese suppliers, including those from Hong Kong, already outnumber those from Taiwan, making China the largest source of suppliers to the US company, according to a Nikkei Asia analysis. Apple also has close ties with several Chinese electronics manufacturers, including Luxshare, Goertek and BYD.
Yangtze Memory’s success is also viewed as a victory for China, as the world’s second-largest economy strives to localise semiconductor production and build industry champions. Yangtze Memory is backed by the China Integrated Circuit Industry Investment Fund, Beijing’s most important chip investment funding vehicle. And YMTC is bullish on its growth prospects, increasing its investment budget from $24bn in 2016 to the equivalent of $32.8bn this year.
The Chinese chipmaker is currently installing equipment at the new chip plant, a key step before it goes into production. The factory will eventually have twice the capacity of the first, several people briefed on the matter said. The total capacity for the two factories will reach 300,000 wafers per month and could help YMTC expand its market share to more than 10 per cent globally.
The company is split into two parallel teams composed of hundreds of top engineers tasked with developing 196-layer and 232-layer flash memory, one of the people said. Its aim is to catch up with foreign rivals.
The most advanced products on the market, which Samsung, Micron and SK Hynix have all succeeded in producing, are 176-layer 3D Nand flash memory chips. They are now racing to create chips composed of more than 200 layers. Kioxia and Western Digital said they will be making 162-layer 3D Nand flash memory by the end of the year.
The more layers a flash memory chip has, the more advanced the chips are — and the harder they are to develop and produce commercially. Nand flash memory is a vital storage component used in all kinds of electronic devices, from smartphones and PCs to data centre servers and connected cars.
Most YMTC flash memory is currently used to make consumer-grade solid-state drives (SSDs), mainly for the Chinese market. Its clients include leading storage makers Lenovo, Longsys and Kimtigo of China, as well as Adata of Taiwan. YMTC has also introduced its own brand, ZhiTai, to sell SSDs directly to consumers.
Its share of the global flash memory market has risen quickly from 1.3 per cent in 2019, when it first put 64-layer Nand flash memory into production, according to Counterpoint Research, which believes it could grab nearly 6 per cent of the market by 2023, up from 4.8 per cent in 2021.
Brady Wang, an analyst at Counterpoint, told Nikkei Asia that Yangtze Memory had been working on its technology even before the company was formally launched in 2016. It had demonstrated its capabilities and gradually become a viable global player after years of effort, Wang said. It had also more than doubled its payroll in four years, to about 8,000 employees currently.
“It recruits many engineers and veterans who have Chinese backgrounds but used to work for multinational tech and chip companies,” Wang said. “Managing a plant, however, is different from managing several plants at a massive scale. It remains to be seen if it [can] successfully ramp up production.”
Political tension between the US and China also increases uncertainties for Chinese companies like YMTC, Wang said.
Washington has slowed the advance of China’s semiconductor industry by adding the country’s top chipmaker, Semiconductor Manufacturing International Co, and the telecom equipment group Huawei, to a trade blacklist to restrict their use of American technology. Yangtze Memory has been among the most aggressive companies in pushing ahead with the development of domestic chipmaking equipment, but it continues to maintain good relationships with US and other foreign vendors to ensure its expansion plans come to fruition.
YMTC declined to comment for this story.
A version of this article was first published by Nikkei Asia on June 23, 2022. ©2022 Nikkei Inc. All rights reserved.
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