This article is an on-site version of our Unhedged newsletter. Sign up here to get the newsletter sent straight to your inbox every weekday
Good morning. A few words to start on yesterday’s Covid piece, which expressed worry that the US could go the way of Austria this winter. Quite a few readers wrote to say that the key 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? It’s population did not suddenly get more dense. Second, some of the highest rates of Covid infection in the US are in low-density states such as Alaska.
You will have noticed that neither Ethan nor I are epidemiologists, so now we move back to familiar territory: the Federal Reserve and environmental, social and governance, or ESG, investing. Email us: firstname.lastname@example.org and email@example.com.
Time to ditch “transitory”, Fed chair Jay Powell told the US Senate on Tuesday. This terminological declaration, paired with an expression of support for faster tapering, smooshed the yield curve. The 10-year Treasury note fell 9 basis points as the two-year stayed flat. Expectations for rate increases are moving forward, too: markets on Tuesday dutifully priced one in by March 2022. Stocks were grumpy.
We’ve written on the transitory-or-permanent debate before. It will rage on whatever words Powell uses. But given all the heat the term has generated, was introducing “transitory” into the lexicon a bad idea from the outset?
Chatter about the term picked up in April, when core inflation topped 3 per cent and Powell told reporters “these one-time increases in prices are likely to have only transitory effects on inflation”. By May, the term had exploded into the public consciousness. Here’s Google searches for “transitory” in 2021 (the index is relative to the highest point on the chart):
But the concept debuted well before that, back in May 2019. At the time Powell used the term to describe entirely different circumstances. Inflation was about 1.6 per cent, below the Fed’s target. Questions about the US central bank’s commitment to a symmetric inflation target were growing louder. Wary of the scepticism, Powell told reporters:
“We suspect that some transitory factors may be at work . . . And I’d point to things like portfolio management, service prices, apparel prices and other things. In addition, the trimmed mean measures of inflation did not go down as much. Indeed, the Dallas trimmed mean is at 2 per cent.”
Sound familiar? The suspects are different — portfolio management instead of used cars — but the story is the same. “The (dis)inflation we’re seeing is due to idiosyncrasies that will go away and leave the underlying price trends in place. Go have a look at the trimmed-mean index in the meantime.”
From Powell’s perspective, the appeal of “transitory” is clear. It sends the message that the Fed will not tighten policy in response to what it considers idiosyncratic spikes in inflation. It is a way of jawboning expectations for future rates down, and assuring the market a classic “Fed mistake” is not in the cards, without committing to a specific response to any one data threshold.
But the concept invites misunderstanding, as Powell rightly said in his Senate testimony Tuesday:
“So I think the word transitory has different meanings to different people. To many, it carries a [sense of] time, a sense of [being] shortlived. We tend to use it to mean that it won’t leave a permanent mark in the form of higher inflation. I think it’s probably a good time to retire that word and try to explain more clearly what we mean.”
“Won’t leave a permanent mark in the form of higher inflation” is clear enough: it mean that after the inflationary incident is over, trend inflation will go back to historically normal levels. That interpretation is consistent with how Powell used the term all along. But that use is also compatible with an inflationary incident that goes on for quite a while. But neither the market nor the public had ears for that level of subtlety. So in the end, the transitory story was more confusing than illuminating.
Using the term as Powell did was a mistake, but a small one. Powell has shown willingness to adapt on the fly and put data over dogma. Remember: both Powell’s patient response to inflation and his view that it won’t stick could still be vindicated. If inflation moderates to 2-2.5 per cent as late as, say, the middle of next year, it will not feel transitory. But from the point of view of history, an inflationary period that lasts only a little over a year — a real possibility — will look very transitory indeed. (Ethan Wu)
Glencore and Bluebell
Bluebell, a smallish activist investor fund that has had some success harassing the likes of Danone and GSK, wants the commodities conglomerate Glencore to spin off its coal business into a separate entity. It thinks a split will raise the value of the whole because coal is a drag on the valuation of Glencore’s non-coal assets (which mostly come from extracting and trading metals).
Bluebell argues that the coal business imposes 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 huge barrier for wider investment in Glencore’s ex-coal business . . .
“A clear separation between carbonised 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 drag on the cost of capital.
Bluebell might well be right that there is an ESG-driven coal discount (though the point is not obvious: Glencore trades at similar multiples of earnings, and at higher multiples of ebitda, as its coal-free peers Anglo American and Rio Tinto). It also might well be right that the coal industry is going to wither even faster than the market anticipates.
What is quite wrong is Bluebell’s view that Glencore spinning off its coal assets will help the fight against global warming. Glencore has committed to winding down and closing its coal assets over the next 30 years, but Bluebell says that:
“The simple concept that thermal coal should continue to be part of Glencore’s portfolio until 2050 is to us, as a company shareholder, both morally unacceptable and financially flawed.”
The necessary implication is that spinning off 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 because carbonised and decarbonised assets have started to attract very different pools of capital at significantly different costs. By separating businesses with different [carbon-dioxide] footprint, it will become possible to foster a global reallocation of capital towards more sustainable companies, which in itself is a powerful force to drive decarbonisation. Vice versa, 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 stock price, higher-yielding bonds) and therefore have less money to invest in coal extraction, leading to less coal burnt and less carbon in the air. This is gibberish from front to back.
How much the hypothetical new entity will invest in coal assets also depends on the return on capital for mining coal, not just the cost of capital alone. Divestment campaigns drive those returns up (assuming stable demand) by making coal assets cheaper to buy and limiting coal supply. It is anything but obvious that the balance between cost of and return on mining capital in coming years will lead to less coal mining.
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-subsidisation is economically inefficient, which is debatable, and is in any case a separate issue.
Bluebell tries on another argument, as well:
“By transferring existing in-house coal expertise to a separate entity — with the commitment to apply the same (and possibly tighter) coal ESG policy currently in place at Glencore group level — it would be possible to spin-off coal whilst maintaining unchanged (and possibly improving) the company’s existing commitment of responsible ownership.”
The argument is that when the coal business is separated, and all the shareholders who don’t like owning coal sell to investors who are perfectly happy to own coal, the sustainability policies of the coal company will not change for the worse, and may even improve. This is bonkers.
Glencore spinning off its coal business is morally neutral and environmentally irrelevant, but it might be a good move financially.
One good read
Unhedged was shocked to learn from a colleague, who for some reason wanted to remain anonymous, that the pop star Avril Lavigne died in 2003 and was replaced by a body double. Wild stuff.