Quoteworthy: "The bigger mistake to make — let’s put it that way — would be to fail to restore price stability" — US Fed chairman Jerome Powell, on prioritising fighting inflation over concerns of pushing the US economy into a recession because of rate hikes.
Jim Chanos’ latest big short: data centre REITs
According to the Financial Times (FT), short seller Jim Chanos believes that data centres in REITs that are not owned by Alphabet, Microsoft and Amazon are going to be behind the curve, so to speak.
The web service arms of the trio — Google Cloud, Amazon Web Services and Microsoft Azure — have their cloud services housed in their own leading edge data centres. For instance, Google has a state-of-the-art data centre in Jurong.
Chanos is quoted to have said the cloud is growing but “the cloud is [the REITs’] enemy, not their business. Value is accruing to the cloud companies, not the bricks-and-mortar legacy data centres”.
In fact, Alphabet, Amazon and Microsoft are likely to be the REITs’ biggest competitors, not their biggest customers. When your biggest competitors are the three most vicious competitors in the world you have a problem, Chanos is reported to have said.
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Data centres owned by groups such as Digital Realty Trust and Equinix are vast warehouses of servers that power large swathes of the internet, the FT explains. The growth in demand for data centres has been a big theme for institutional investors, who are seeking to tap into the global expansion of cloud computing, the FT adds.
As an example, investors in the Asian timezone bought into Digital Core REIT, whose sponsor is Digital Realty Trust, at 88 US cents ($1.22) back in December 2021 during its IPO. As at June 29, its unit price was 82 US cents. In fact, Digital Core REIT is down almost 29% since the start of the year
The reasons for Digital Core REIT’s performance could be threefold. The main reason is, of course, interest rates. In addition to an impact on Digital Core REIT’s unit price, its capital management leaves a lot to be desired. In its business updates in 1Q2022, the REIT manager started the year without any fixed rate debt. Moreover, all the debt taken on at IPO is not staggered, and expires at the same time.
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On April 21, the manager announced that it had established a minimum target of 50% fixed rate debt, and entered into a US$175 million interest rate swap to mitigate interest rate risk. The REIT has some US$500 million of debt, of which US$350 million has been drawn down, and the remaining US$200 million is undrawn. The amount that is on fixed rates is just US$175 million. Cost of debt is 2.1%.
The cost of debt includes the pro forma cost for US$175 million interest rate swap, assuming the swap was outstanding for the entire 1Q2022 period. Actual average cost of debt for the 1Q2022 period was 1.2%, the manager says. This implies that cost of debt in 2Q2022 is likely to be a lot higher, as cost of debt is likely to rise from here on.
Secondly, the REIT’s manager announced: “In April 2022, Digital Core REIT’s fifth-largest customer, a privately held IT service provider occupying 2.7 MW of capacity in Toronto, filed for bankruptcy protection.” — Goola Warden
China’s economy shows signs of improvement as Covid eases
China’s economy showed further signs of improvement in June with a strong pick-up in services spending as Covid outbreaks and restrictions were gradually eased.
The official manufacturing purchasing managers index rose to 50.2 from 49.6 in May, the National Bureau of Statistics (NBS) said on June 30, slightly below the median estimate of 50.5 in a Bloomberg survey of economists. It was the first time since February that the index was above 50, indicating expansion in output compared with May.
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The non-manufacturing gauge, which measures activity in the construction and services sectors, climbed to 54.7, the highest in more than a year and well above the consensus forecast of 50.5.
Government restrictions to contain Covid outbreaks have gradually eased over the last month. The financial hub Shanghai lifted its two-month lockdown at the start of June by allowing more shops to reopen, more factories to resume production, and for port operation to pick up.
The data suggests “the pace of recovery accelerated as the Covid situation stabilised,” said Peiqian Liu, chief China economist at NatWest Group. There was a “broad based but still soft recovery in both production and new orders”, and the figures show the rebound is still milder compared with the recovery from the Wuhan lockdown in 2020, she said.
Some 19 of the 21 sectors in the service sectors tracked in the survey returned to expansion last month, up from just six in the previous month, according to the NBS. Gauges of sectors previously hit badly by the outbreaks have all improved, such as railway transport, air transport, accommodation, catering and entertainment.
The recovery remains fragile though as the country sticks to its zero-Covid strategy, meaning restrictions could be tightened if outbreaks of the highly transmissible Omicron variant flare up again. Chinese President Xi Jinping reaffirmed his zero-Covid policy this week, saying it was the most “economic and effective” for the country.
Economists, meanwhile, are holding firm on their gross domestic product growth forecasts for this year. The median projection in a Bloomberg survey for 2022 growth is 4.1%, well below Beijing’s annual target of around 5.5%. Bloomberg’s aggregate index of eight early indicators showed some improvement in June, though the recovery remains muted. — Bloomberg
Powell says US economy in strong shape, Fed can avert recession
Federal Reserve Chair Jerome Powell said the US economy is in “strong shape” and the central bank can reduce inflation to 2% while maintaining a solid labour market, even though that task has become more challenging in recent months.
He also vowed to ensure rapid price increases do not become entrenched, saying that “we will not allow a transition from a low inflation environment to a high inflation environment.”
“We hope that growth will remain positive,” Powell said during a panel discussion on June 29 during the European Central Bank’s (ECB) annual policy forum in Sintra, Portugal. Household and business finances are also in solid shape, and “overall the US economy is well positioned to withstand tighter monetary policy”.
Raising interest rates without sparking a recession “is our aim and we believe there are pathways to achieve that”, Powell said, reiterating comments he has made this month after the Fed on June 15 raised interest rates by 75 basis points, the biggest increase in three decades. Powell has signalled that another move of that size — or a 50 basis-point increase — will be on the table when they meet again in late July.
He reiterated on June 29 that the Fed is raising rates “expeditiously” and aims to move “into restrictive territory fairly quickly,” referring to having borrowing costs at levels that would restrain rather than spur economic growth.
Powell and his colleagues have pivoted aggressively to fight the hottest inflation in 40 years amid criticism that they left monetary policy too easy for too long as the economy recovered from Covid-19. They have raised rates by 1.5 percentage points this year and officials forecast about 1.75 points of further cumulative tightening in 2022.
Powell said financial markets’ pricing for Fed rate-hike expectations is “pretty well aligned with where we’re going”, noting that it is roughly in line with the forecasts that Fed policymakers issued earlier this month.
Asked by panel moderator Francine Lacqua of Bloomberg Television if he is concerned about the yield curve — whose partial inversion is seen by some as a possible recession signal — Powell said it’s “not a top-line worry right now” and that the Fed is focused on bringing down inflation.
The shift to higher rates has rocked financial markets as investors fret the Fed could trigger a recession. About a third of economists predict a US recession as likely in the next two years, 21% seeing some time with zero or negative growth likely and the rest looking for the Fed to achieve a soft landing of continuing growth and low inflation, according to a survey earlier this month.
Powell spoke on a panel with ECB President Christine Lagarde and Bank of England Governor Andrew Bailey. All three central bankers are trying to lower inflation, which has become a global problem exacerbated by supply-chain disruptions associated with the Covid-19 pandemic as well as surging food and energy prices in the wake of Russia’s invasion of Ukraine. — Bloomberg
