Jun 26, 2019

Axios Markets

By Dion Rabouin
Dion Rabouin

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Situational awareness:

  • Wayfair stock fell 5% after more than 500 employees signed a petition coinciding with a planned walkout to protest the company's sale of mattresses to a detention camp for migrant children. (CNBC)
  • The U.S. is willing to suspend tariffs on an additional $300 billion of Chinese imports while Presidents Trump and Xi prepare to resume trade negotiations. (Bloomberg)
  • Treasury Secretary Steve Mnuchin said the U.S. and China were 90% of the way to a trade deal. (CNBC)
1 big thing: The Powell predicament

Jerome Powell at the Council on Foreign Relations in New York City. Photo: Spencer Platt/Getty Images

Fed Chair Jerome Powell has been put in a tough situation by President Trump and the market ahead of July's FOMC meeting, with his hand forced in the face of historic uncertainty. But he hasn't done much to help himself.

Driving the news: Powell again sought safety in equivocation on Tuesday, noting during a speech at the Council of Foreign Relations that "The global risk picture has changed ... since May 1, significantly," but also saying "it’s important not to overreact in the short term to things that happen to be temporary or transient."

Why it matters: The U.S. economy is at a delicate moment: trade and manufacturing data are worsening, jobs growth is volatile and slowing, and the bond market is bracing for the worst while equity investors keep expecting the best.

Be smart: The Fed chair has responded by embracing what Axios' Felix Salmon calls "constructive ambiguity," pushing back against the blueprint created by predecessors Ben Bernanke and Janet Yellen. They dictated the Fed's plans to the market with forward guidance and long-winded policy statements. Powell has reversed course.

  • "Rate guidance as a tool is about the Fed being in front of markets and leading them to where [the Fed] wants to go," Vincent Reinhart, a 24-year Fed veteran who now serves as chief economist at Standish Mellon Asset Management, tells Axios.
  • "December's [FOMC meeting] showed that if you're leading, you are the target of criticism, both from the markets and the president, so they switched to much more data dependence ... and moved from the front of the pack to the back."

The bottom line: Powell is not just fighting President Trump's continued criticism, but also his trade war's negative impact on the U.S. economy, while also having to hedge against a surprise agreement, Axios' Courtenay Brown writes.

  • An "insurance rate cut" in July could not only prove a policy mistake, but further erode Powell's credibility and the Fed's.
  • But not cutting rates will put him in the crosshairs of the president and the market, which has investors pricing in a 0% chance he doesn't do it.
2. June's sinking U.S. factory activity
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Data: Federal Reserve of New York, Richmond, Dallas; Chart: Chris Canipe/Axios

The onslaught of underwhelming U.S. manufacturing data continued as the Richmond Fed reported factory activity barely expanded during the month, reflecting a decrease in the employment index.

  • Recent Fed data shows negative readings on manufacturing from its regional Dallas and New York bank areas, with the Philadelphia area coming in at 0.3.
3. U.S. debt expected to hit "unprecedented" levels, CBO says

The U.S. national debt will rise to "unprecedented" levels if spending continues on the same trajectory, the CBO reports in its latest projections. The nonpartisan organization predicted debt will almost double from the current 78% of GDP to 144% by 2049.

The intrigue: Things could actually be worse than that. The projection is an 11 percentage point reduction from last year's estimate, based largely on the expectation that U.S. interest rates will remain historically low for the next decade-plus.

  • The CBO projects real rates will be 1.4% by 2029 and 2.2% in 2049.

Still, the agency warns: "The prospect of such large deficits over many years, and the high rising debt that would result, poses substantial risks for the nation and presents policymakers with significant challenges."

4. With cash to burn, pharma deals are all the rage
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Data: 2019 EY M&A Firepower report and Axios reporting; Chart: Axios Visuals

Axios' Bob Herman writes: The pharmaceutical industry has already shelled out more than $200 billion for acquisitions during the first half of 2019, capped off yesterday by AbbVie's $63 billion buyout offer for Allergan.

The big picture: This year's deal-making has already surpassed 2017 and 2018, as drug companies plan for patent losses and jockey for lucrative assets that are advancing in clinical trials, including gene therapies.

Driving the news: The AbbVie-Allergan combination makes 2019 one of the busiest for pharmaceutical deals in the past several years.

The running theme in almost all of these deals: scoop up cancer drugs and gene therapies, which command the highest prices.

Yes, but: AbbVie-Allergan is different. Wall Street has been down on both companies, and this buyout is focused on Allergan's aesthetics drugs, like Botox. It's largely about protecting economic moats, based on AbbVie CEO Richard Gonzalez's comments.

The big question: The Federal Trade Commission is increasing its scrutiny of pharma mergers, including BMS-Celgene and Roche-Spark. So, don't assume every deal will get clean antitrust approval.

Of note: The $188.24 per share AbbVie will pay is 45% more than Allergan's last close. AbbVie's stock dropped 16%, its biggest slide since 2012.

5. S&P warns of trouble cooking in the restaurant sector

U.S. restaurants have been a beacon of hope in the moribund brick-and-mortar retail picture, but they now face trouble of their own, analysts at ratings agency S&P Global warn.

What's happening: "Already, cracks are showing across our rated restaurant universe," Diya G. Iyer, S&P's primary credit analyst, wrote in a note to clients Tuesday.

  • Iyer worries rising wages and increasing delivery costs will weigh on fast food restaurants while changing millennial dining preferences will hurt casual dining.

Details: Despite some improving brands, the rise of food halls and continued pressure on lower-income households this year will work against much of the fast casual and fast food sector, Iyer warns, where Pizza Hut, Wendy's and BossCo (parent of Checkers) have all been downgraded to CCC+ ratings with negative outlooks.

By the numbers:

  • "A new normal is unfolding," Iyer says, with U.S. restaurant sales increasing only 3.6% last year versus a compound annual growth rate of 6.4% between 1970 and 2019, according to the National Restaurant Association.
  • The most concerning development is that industry traffic hit a 9-year low with a 4% reduction in February, while the average cost of a check in restaurants hit a 10-year high, according to U.S. restaurant industry benchmarker MillerPulse.
  • Price increases look unsustainable given negative industry traffic since 2015.

Other worries:

  • Remodeling growth is expected to slow after years of capital spending on technology, especially in casual dining.
  • Restaurants will have to raise prices because of swine flu in China, which has slowed global pork supply.

Yes, but: S&P notes that there have been 0 restaurant defaults in the last 2 years and only 1 a year in the years prior.

Watch this space: "We will continue to closely monitor refranchising efforts that McDonald's Corp., Wendy's, and other major players undertook in recent years," Iyer writes.

  • "The approach passes costs on to the franchise operators, improving margins and free cash flow generation at the franchisor level. But in our view, in some cases it causes potential for strife if mom-and-pop owners feel they shoulder too much expense to execute on the major transformations."
Dion Rabouin