The Fed: No Secrets, No Promises

Good morning. Stocks in PacWest Bancorp crushed after hours, according to reports, he had hired advisers for a sale or capital raise. The Los Angeles-based lender, with $44 billion in assets, has been the subject of speculation because its balance sheet has some of the same flaws that sank Silicon Valley Bank. We seem to be in the midst of a mini banking crisis that neither gets carried away nor dies down. It just broods. Email us: robert.armstrong@ft.com And ethan.wu@ft.com.

The Fed is done, probably

The tightening cycle has come a long way in 14 short months, and yesterday Jay Powell gave an update. He noted that the policy rate had risen by 500 basis points, the Federal Reserve had lost $400 billion in assets and, more recently, a series of bank failures were restricting credit. Inflation, still hot, is down. Yet unemployment is lower today than when the tightening began. This remarkable collection of facts, at the very least, should give us pause.

This is certainly the case for Powell. Although the Fed’s decision, a 25 basis point hike accompanied by new language teasing a June rate pause, was widely expected, what struck us was how equivocal it all appeared. .

Start with the new language. In March, the Fed said it expected “further policy tightening to be appropriate.” Yesterday that was dropped for looser wording saying the central bank would weigh multiple factors “to determine how much further policy tightening might be appropriate.” Powell called it a “significant change”.

When asked if this suggested a trend to tighten (rather than stall), Powell dodged the question. However, many Fed watchers took it that way. Stephen Stanley, chief US economist at Santander, said “the new language reveals a bit of a hiking bias.”

But bias or not, Powell reiterated the long-standing message that the Fed is just waiting for the data like everyone else. He said he didn’t know what would happen to rates, credit or the economy. From yesterday’s press conference, here is his response to the question of whether the current monetary policy stance is “tightly enough”:

You have real rates of 2%. This is significantly above what many people would consider the neutral rate. The policy is therefore strict. And you see that in interest-sensitive activities. And you’re starting to see it more and more in other activities as well. And if you put the credit crunch on top of that and the [quantitative tightening] it’s in progress, I think you feel that we may not be far away. Maybe even at this level.

In other words: maybe, it’s hard to say, a lot could happen. The sentiment was repeated in this answer as to whether a soft landing is still possible:

I keep thinking that it’s possible this time will be really different. And the reason is that there is so much excess demand in the labor market. ..

There’s no promise there. But it just seems to me that it’s possible that we could continue to have a cooling labor market without having the big increases in unemployment that have accompanied many earlier episodes. It would be contrary to history. [But] avoiding a recession is in my opinion more likely than having a recession. But the case of a recession – I don’t rule that out either.

And again asked about the extent of the regional banks’ credit crunch:

We raised interest rates [which restrict credit] by the price mechanism. And when banks raise their lending standards, it can also lead to a credit crunch in a broadly similar way. It is not possible to make a clean translation between one and the other. . . ultimately, we need to be honest and humble about our ability to make an accurate assessment. This complicates the task of reaching a restrictive position.

On credit terms, Powell offered a piece of new information. Members of the Fed had preview access yesterday to its opinion poll of senior loan officers (the “Sloos”, pronounced as sluice), a very important indicator. When asked what it would show, he called the investigation “broadly consistent” with what already exists in Fed investigations and bank revenue calls. Carl Riccadonna of BNP Paribas told us that even before yesterday’s meeting,

All of these things told us that there was likely further tightening of lending conditions, but not a catastrophic drastic change in the lending environment. We knew [it wouldn’t be] a Frankenstein Sloos that would have scared the Fed from tightening [yesterday]. It will likely get progressively worse when we get the data on Monday.

Powell’s noncommittal stance reflects a Fed trying to delicately cool a consumer driven economy with the indelicate tool of monetary tightening. In the face of uncertainty, his message was: We’ll let you know when we find out. No promises, no secrets.

And that’s just as far as it goes. But our concern is that unbiased ambivalence may be the wrong approach at the top of a hiking cycle, precisely when we should most expect things to break (see: PacWest). Next month, the Fed would be wise to put the tightening campaign on hold. (Ethan Wu)

Uber and stock-based compensation

Longtime readers of FT’s Alphaville blog will remember Izabella Kaminska’s long career argument that Uber, the ride-sharing app, has a hopelessly bad business model.

The argument, in essence, is that even on a global scale, Uber has (at best) the profitability profile of a capital-intensive taxi company, not a thin-cap tech company. It can’t charge a big premium over what it costs to pay drivers and cover wear and tear on cars. Even when he holds a monopoly or duopoly position in carpooling, it is not certain that his service has clear advantages in terms of cost/speed/comfort/convenience compared to other solutions such as bicycles , buses, metro and local car services. By this argument, profits well above Uber’s cost of capital seem unlikely to materialize.

I have always bought this argument. But now look at this:

This is Uber’s free cash flow (operating cash flow minus capital expenditures) on a rolling 12-month basis. The business now generates cash profits. Not tons – around 50 cents per share, leaving stocks to trade at nearly 80 times free cash flow. But still: benefits! In the March quarter alone, the company generated $549 million in free cash flow. “Frankly, for me, businesses need to generate free cash flow, so we’ve taken the lead on that,” Chief Financial Officer Nelson Chai said. Uber shares are up 22% this month.

There is a problem, however. This is stock-based compensation, which free cash flow does not take into account, as it is a transaction where cash is not exchanged. But it is a real expense and moreover should be treated as a cash expense.

Here’s why. Imagine a company that issues new stock to the public and then uses the money raised to pay employees. One would not be tempted to exclude these cash expenditures from free cash flow. But in case the company removes the public and directly gives the shares to the employees, the same economic value is given, but in a different form. We can’t argue that a company that only has free cash flow before stock-based mix is ​​truly cash flow positive. It’s just a business that breaks even and looks profitable because it pays its employees in ways other than cash.

Here’s Uber’s free cash flow with stock-based compensation deducted, what we might call “true free cash flow”:

Uber was, in terms of free cash flow, a barely breakeven business in the last 12 months (in terms of operating income and GAAP net income, it is still incurring losses; and the least said of the company’s preferred earnings measure, “adjusted ebitda,” the best).

The idea that the company still isn’t particularly profitable because it hasn’t scaled yet is, of course, laughable. Reservations (passenger payments to Uber) are operating at an annual rate of $125 billion; 24mn of Uber trips were made per day in the last quarter.

When can we just say it’s bad business? Maybe not enough Again. The company continues to increase bookings at an annual rate of 20%, and a combination of price increases and cost discipline means that the profitability trend is gradually moving in the right direction, as shown in the graph of the real free cash flow. The question is to know what is the equilibrium level of profitability of the company. I don’t know how to estimate that, but I can’t think of a reason why it would be so different from what we’re seeing right now, on a scale of 24 minutes of rides per day. Can you?

A good read

A decisive addition to the debate on dedollarization by Adam Tooze.