Here’s Fed chair Jerome Powell, laying the groundwork for easier money ahead in Monday remarks at the Economic Club of Washington:

Our test has been for quite some time that we want to have greater confidence that inflation was moving sustainably down towards our 2% target, and what increases confidence in that is more good inflation data. And lately, we have been getting some of that. . .

If you wait until inflation gets all the way down to 2%, you’ve probably waited too long, because the tightening that you’re doing, or the level of tightness that you have, is still having effects which will probably drive inflation below 2%.

The Federal Trade Commission turned the screws on Big Restaurant Friday, unveiling new actions designed to thwart “unfair and deceptive” practices.  Among the items on the regulator’s menu: a crackdown on undisclosed “junk fees” for technology, employee training, marketing and property improvements levied outside of franchise disclosure documents, as well as the use of non-disparagement clauses designed to dissuade complaints over alleged mistreatment.

“Franchising is a chance for Americans to build a business, but the FTC has heard concerns about how unfair franchisor practices, like a failure to fully disclose fees upfront, go unreported thanks to fear of retaliation,” stated FTC chair Lina Khan. “Today, the Commission is making clear that contractual terms prohibiting franchisees from reporting potential law violations to the government are unfair, unenforceable and illegal.”

Enhanced government scrutiny of franchisor vs. franchisee disputes arrives against a rough-and-tumble operating backdrop, as the amply levered dining industry contends with a downshifting consumer and persistent cost pressures. Citing data from Bloomberg, analysts at Bank of America relay that median restaurant sales growth slipped to a 2.2% annual clip in June from 5% in May and more than 6% at the end of last year, while nationwide foot traffic ebbed 3.3% over the first six months of 2024 according to Black Box Intelligence. 

Last week, seafood chain Kura Sushi ratcheted down its full fiscal-year sales forecast to $236 million from $245 million using the midpoint of provided ranges, with management citing a “sudden and unexpected” business slowdown beginning three months ago. Kura, which posted a 28% year-over-year revenue gain over the three months through May, likewise warned that California’s FAST Act, which established a statewide $20 hourly minimum wage for fast food employees, has spurred “a general perception that restaurants as a category have become expensive, introducing industry-wide pressures regardless of a given restaurant's relative value.”

Such sticker shock likewise bedevils casual dining mainstay Darden Restaurants, as analysts at Jefferies downgraded the Olive Garden parent to “underperform” Thursday, introducing a $124 per share price target, 13% south of current levels and the lowest bogey among 31 firms covering the name.  Darden’s “disciplined approach” to discounting could prove a competitive impediment, as an industrywide uptick in promotions threatens the firm’s market share. “In the context of lingering lower-end [consumer] weakness, we believe some recalibration on the value front may be needed,” the investment bank contends.

Meanwhile, planet Earth’s pre-eminent fast-food chain faces an “underwhelming” response to its own high-profile discounting initiative, Gordon Haskett finds, as the McDonald’s $5 meal deal – featuring a McDouble or McChicken sandwich, small order of fries, small soda and four-piece chicken nuggets – which debuted on June 25, was met with a mere 1% annual increase in foot traffic over the 11 days through July 5. The independent research firm added that it expects the Golden Arches to roll out “increasingly aggressive” promotions in the coming quarters.  

Peers at Truist Securities likewise write that the meal deal (which yields profit margins of 1% to 5% rather than the typical 5% to 10% range per estimates from fast-food industry analyst Mark Kalinowski ) “does not appear to have reignited momentum” for the MCD top line, adding that last month ended on a “low note” for Restaurant Brands International-owned peer Burger King. 

Where's the beef? See the analysis “With a side of debt” in the current edition of Grant’s Interest Rate Observer dated July 5 for more on the inherent tension between so-called asset light restaurant owners and their often-put-upon franchisees, as well as broader industry tribulations in the wake of the pronounced post-Covid inflation. 

Stocks assumed their usual green hue, with the S&P 500 and Nasdaq 100 each settling higher by about 0.3% after giving back stronger early gains, while the small-caps remained white hot with the Russell 2,000 logging a near 2% advance to bring its cumulative three gains to 6.8%.  Treasurys saw some bear steepening as the long bond rose seven basis points to 4.46% and two-year yields ticking to 4.44% from 4.45% Friday, while WTI crude edged below $82 a barrel. Gold pushed above $2,420 per ounce to draw within about 1% of its prior peak, bitcoin rebounded to $63,700 and the VIX toggled above 13. 

- Philip Grant

I’d buy that for a dollar! Incorrigible Tesla boss Elon Musk took to his X social media platform to trumpet the electric vehicle’s full self-driving technology, responding to a video demonstration of the latest iteration, known as FSD version 12.4.3, with the following: “Buying anything except a Tesla will seem like buying a horse & buggy.”

On that score, time will tell.  As the Washington Post documents today, the automaker faces parallel investigations from the U.S. Department of Justice, California’s Department of Motor Vehicles and the Securities and Exchange Commission regarding the veracity of claims to customers and investors regarding FSD and Autopilot, Tesla’s software suite powering the nascent technology, which retails for $8,000. 

“Contrary to Tesla’s repeated promises that it would have a fully self-driving car within months or a year, Tesla has never been merely close to achieving that goal,” allege litigants in a civil complaint logged with the U.S. District Court for the Northern District of California. 

Meanwhile, Bloomberg reports that Musk et al. are pushing back a showcase of the firm’s so-called Robotaxi to October from Aug. 8, marking the latest setback for the long-promised driverless car service. As the Post notes, Musk declared in 2019 that Tesla would deploy one million Robotaxis by the end of 2020, utilizing existing but idle vehicles. “The fleet wakes up with an over-the-air update,” he explained prior to the pandemic. 

Or, as the case may be, hits the snooze button. 

Call it Schrödinger’s coin: The crypto category contends with simultaneous bull- and bear-market conditions, as digital assets sport a combined valuation north of $2.1 trillion by Coinmarketcap.com’s count, up nearly 100% year-over-year, though that figure is likewise down 20% from early March. Similarly, bitcoin enjoys a near 90% gain from mid-July 2023, while nursing a 17% drawdown over the past five weeks. 

Indeed, recent developments highlight the concurrent states of prosperity and gloom. This morning, industry mainstay MicroStrategy announced a 10:1 stock split effective in early August, as the software provider-cum-bitcoin speculation vehicle looks to render its shares “more accessible to investors and employees.”  Following a 238%, one-year rally, loss-making MicroStrategy sports a $24 billion market cap, nearly double the $13.1 billion valuation assigned to its cache of 226,331 BTC.

Yet as one digital avatar basks in Mr. Market’s adulation, another throws its backers for a loop. Bloomberg reports today that investors owning some 70% of Skybridge Capital’s crypto-focused hedge fund asked for their money back in the latest redemption window earlier this year, with the fund, which is structured to return investor cash via tender offers, buying back only 7% of shares outstanding during that period.  

That development marks a curious contrast with the $1.6 billion fund’s 46.4% gain over the 12 months through March, though Skybridge Founder and short-lived former Trump administration communications director Anthony Scaramucci told Bloomberg that the deliberate pace of redemptions is within “the ambit of the prospectus.”

Farther-flung corners of the crypto universe, meanwhile, are slogging through the summer heat. The Capriole Investment’s Crypto Speculation Index, which measures the share of alternative tokens outperforming bitcoin on a rolling 90-day basis, has slumped to 7% from a near 60% share in January.  

Nearly 15,000 so-called altcoins are in circulation by data firm CoinGecko’s count. Most of that cohort “are illiquid and struggle to prove their use cases,” as CoinDesk puts it, though prior sub-10% readings from that indicator preceded substantial, broad-based crypto rallies in early 2019, late 2020 and the back half of 2023. 

A pair of prominent such tokens could certainly use a renewed jolt of speculative appetite: Doland Tremp and Jeo Boden – memecoins depicting the current Presidential nominees – are off 74% and 96% from their respective peaks in early June and early April, leaving those unofficial avatars valued at $39 million and $25 million, respectively.  

The inspiration for one of those coins duly plays his part in trying to turn the tide. Challenger and erstwhile commander-in-chief Donald Trump will deliver a 30-minute address at a bitcoin themed conference in Nashville on July 27, organizers announced yesterday, a speech “likely to further burnish a self-assigned image of crypto booster,” CoinDesk predicts. 

   
The official art of the unofficial presidential altcoins

A cooler-than-expected June CPI print spurred an intense rotation in stocks, with the small-cap Russell 2,000 vaulting nearly 4% and the tech-heavy Nasdaq 100 slumping 2.2%, while the S&P 500 settled 0.9% in the red. Treasurys enjoyed a frenzied short-end rally in anticipation of imminent Fed rate cuts, with two-year yields dropping a dozen basis points to 4.5%, while the long bond saw a more measured decline to 4.41% from 4.47% Wednesday. WTI crude advanced to $83 a barrel, gold ripped to $2,414 per ounce to approach its May peak near $2,450, bitcoin edged modestly lower at $57,500 and the VIX remained below 13 once more. 

- Philip Grant

From the Sporting News: 

The Congressional Baseball Game isn't the only place you can watch politicians play ball in 2024—just look to Sioux City, Iowa, where Iowa state representative J.D. Scholten (D) just pitched a strong outing after a 17-year hiatus from American baseball.

Scholten played baseball in various independent leagues from 2003-07, pitching for Sioux City for the majority of the time. He then took time off from the sport and eventually found himself running for Iowa congress. 

Somehow, amid his political career, he has found his way back to the diamond and has been successful in doing so. His first appearance back in his home state went as well as one could have hoped: a 6.2 inning performance where he struck out two and gave up seven hits and two runs.

A real estate battle royale takes shape in U.S. District Court: Realtor.com parent firm Move, Inc. filed a lawsuit against CoStar Group (ticker: CSGP) in California last week “over the alleged theft of portal data and documents,” as HousingWire first reported on July 3.  

According to the complaint, a longtime Realtor.com staffer who migrated to CoStar unit Homes.com earlier this year subsequently accessed sensitive information from his former employer on dozens of occasions, gathering user traffic metrics along with contact information and compensation data for other Realtor.com employees in violation of state and federal statutes. “There is nothing wrong with lawful – even intense – competition,” the complaint reads. “But competitors should never be allowed to cheat and steal to get ahead.” 

CoStar offered no dull soundbite in its own defense:

The employee in question is a mid-level manager who writes and edits stories about condos. [It’s] safe to say he has zero input into Homes.com’s strategy. And even Move’s creative writing exercise doesn’t pretend that CoStar itself engaged in any misconduct. . . Realtor.com is losing the battle with Homes.com and its attempt to change the story doesn’t change that reality.

As HousingWire notes, the rival firms have long vied for the mantle of second-largest residential real estate portal behind Zillow, as the industry adapts to a March settlement between the National Association of Realtors and litigating home sellers which could serve to cut broker commissions by some 30%, per estimates from Keefe, Bruyette & Woods.

Indeed, Move’s complaint asserts its number two status by the lights of “every independent third-party [data] source [it] can identify,” including Comscore, Nielsen and others, adding that “Homes.com is last” among the industry’s four entrants. Realtor.com ranks 21st within the lifestyle section of the Apple App Store, behind only Zillow at number three and far ahead of Homes.com’s 128th position (fellow entrant Redfin sits in 25th place). 

CoStar has led a largely charmed existence from its 1987 founding, growing into a leading aggregator of commercial real estate data before branching out into the residential business. Witness the ongoing 52 straight quarters of double-digit year-over-year revenue growth, 20%-plus compound annual share price appreciation spanning the 10 years through March, universal admiration of Wall Street analysts (none of the 17 polled by Bloomberg say “sell”) and wide berth from the bears, with short interest summing to 2.3% of the float. 

Yet slowing growth, execution risk surrounding an ambitious, an expensive Homes.com advertising campaign and a skyscraping valuation equivalent to 160 times projected 2024 earnings informed a bearish verdict in the March 29 edition of Grant’s Interest Rate Observer (“Sell a great stock”). Shares have since logged a 26% decline, lagging the 7% rise in the S&P 500 including reinvested dividends and minus 3% return for its equally weighted counterpart.

Recent developments illustrate a new, potentially less lucrative state of play for CoStar investors. On April 22, the firm announced the acquisition of data provider Matterport for $1.6 billion in an even mix of cash and stock, forking over a 216% premium to the target’s undisturbed share price and equivalent to just over 10 times Matterport’s 2023 revenue (top line growth registered at 16% last year). Following the close of business on July 3, the firms disclosed receipt of request for additional information from the Federal Trade Commission, suggesting unwelcome regulatory scrutiny towards the prospective transaction, which is slated to close in the fourth quarter. 

Rivals in the fiercely competitive industry, meanwhile, maintain a full court press. Late last month, Zillow revealed a new venture with Moody’s in which the rating agency will furnish data and analytics for its multifamily residential division, while Zillow will provide multifamily rental property data for Moody’s own CRE platform.  “It seems like they have joined forces to attack CSGP,” muses an informed friend of Grant’s. 

On the bright side, those recent struggles don’t look to be keeping CoStar founder and CEO Andy Florance down. The Wall Street Journal reported last week that Florance parted with a one acre, 9,700 square foot beachfront home in the Florida panhandle for $28.5 million, topping a $25 million deal logged in 2022 to mark the highest transaction price ever recorded in the so-called redneck Riviera. Florance purchased the dwelling for $15.1 million in 2020. 

Stocks crept higher by 10 basis points on the S&P 500 as molasses-type price action persists at the index level, while a strong three-year auction headlined another quiet day for Treasurys as the yield on the long bond rose to 4.49% from 4.46%. WTI crude slipped below $82 a barrel, gold edged higher at $2,364 per ounce, bitcoin climbed to $57,900 and the VIX notched its 11th straight session south of 13. 

- Philip Grant

If it’s not on your phone, did it really happen?  From the Independent:

Two couples were filmed fighting with each other at an observation deck in Tibet allegedly to secure the best selfie spot while attempting to climb Mount Everest.

The incident took place on June 25 after a tour guide asked the group to pose together on the viewing platform next to the Everest Elevation Measurement Monument for a photo.

Command and patrol: Beijing is putting the finishing touches on laws to establish a financial stability guarantee fund to backstop stricken institutions and snuff out potential contagion. 

To be sure, tinder for such an imagined conflagration is in abundant supply. Commercial banking assets in the Middle Kingdom reached $58.2 trillion at the end of May, equivalent to more than half of last year’s GDP (not China’s, but the world’s) and towering over the U.S.’s $23.3 trillion figure.The tally of debt amassed by so-called local government financial vehicles, or municipal entities which fund output-flattering spending projects, reached some $9 trillion as of Dec. 31 per the IMF, up 65% from the year-end 2020 figure and far above the $3.3 trillion in aggregate borrowings among U.S. state and local authorities. 

A now-sketchy growth picture brings that towering debt stack into sharper relief.  Yields on China’s onshore 10-year sovereign bonds touched 2.18% yesterday, marking the lowest level on record dating to 2002 and underscoring a “pessimistic mood on the economy,” per Bloomberg chief Asia FX and rates strategist Stephen Chiu. 

China’s lynchpin housing market, meanwhile, continues to sag. Home prices across 70 major cities fell by 0.71% month-over-month in May per the National Bureau of Statistics, the steepest sequential drop in that government-compiled data series since October 2014.  Property-sector investment likewise sank 10.1% year-over-year from January to May, further downshifting from a 9.8% decline during the first four months of 2024.

Tellingly, perhaps, Wall Street is packing its bags. The Financial Times relays today that a sample of seven U.S. and European-headquartered investment banks have slashed their headcounts in China by a combined 13% from levels seen in 2022, as year-to-date IPO volumes in the world’s second-largest economy reached only $8.3 billion as of May 31 per Dealogic, the worst such start to a year since 2009.

Those dynamics reflect a “vicious cycle” according to Han Lin, China country director at consulting firm The Asia Group. “Weak deal flow means less investment in onshore capability, which further limits deal flow.”  Mincing no words, JPMorgan boss Jamie Dimon commented at a May conference that business had “fallen off a cliff.”  

Stocks staged a strong intraday advance following dovish commentary from Fed chair Jerome Powell, with the S&P 500 settling higher by two-thirds of a percent to break from its narrow range and top the 5,500 threshold for the first time. Treasurys managed a moderate bounce with the long bond dropping four basis points to 4.6%, while WTI crude ticked to $83 a barrel and gold finished little changed at $2,329 per ounce. Bitcoin slipped back below $62,000 and the VIX stayed at 12. 

- Philip Grant

From the Financial Times:

Sales of olive oil have plunged in its Mediterranean heartland as Spaniards and Italians are forced to shun their most beloved culinary ingredient following steep price rises. 

Ignacio Silva, chief executive of Deoleo, the world’s biggest olive oil seller by revenue, said cost-conscious consumers were changing their habits to cope with the impact of droughts that have wrecked harvests. 

“We’ve clearly touched a price that is a problem for Spanish and Italian consumers,” he told the Financial Times, alluding to falling sales of Deoleo brands including Bertolli and Carbonell.

A kilogram of the foundational foodstuff now wholesales for about €7 ($7.49) in global number one producer Spain, data from Expana Benchmark Prices show, compared to a bit more than €1 per kilo at the start of 2021.

Which way, Mr. Market? Placid price action in stocks following the steep post-October rally is spurring a virtuous cycle in equity derivatives. Thus, Bloomberg reports that straddle and strangle strategies, which entail selling both bullish call and bearish put options at various strike prices in a bet on limited moves, are increasingly en vogue, in turn helping contribute to index level stability. 

The S&P 500 has now gone more than 300 sessions without logging a single day 2% decline, its second longest such streak in the post-2008 era. Similarly, the Chicago Board Options Exchange's CBOE Volatility Index (VIX) has topped 15 on a closing basis only 21 times in the year-to-date, rarely approaching its three-decade average of near 20 over that period. 

“We are seeing absolutely pervasive at-the-money volatility selling from customers,” Nomura cross-asset strategist Charlie McElligott writes. Meanwhile, the broker dealers who stand on the other side of that trade – accumulating calls and puts alike from their income seeking customers – hedge their positions by selling rallies and buying dips, a dynamic which is “simply choking out the ability” for benchmark gauges to sustain material moves, McElligott concludes. 

Yet as plain vanilla pervades at the index level, those looking to add zest to their portfolios have a new recipe at their disposal. Yesterday, exchange traded funds issuer T-Rex Group filed paperwork with the SEC to pave the way for a contraption offering two times the daily return in MicroStrategy, Inc. (ticker: MSTR), the loss-making enterprise software provider-cum-bitcoin speculation vehicle helmed by crypto evangelist Michael Saylor. T-Rex likewise plans to introduce an inverse MSTR fund for those of a bearish bent. 

MicroStrategy, which boasts a cache of 214,400 bitcoins currently valued at just over $13 billion, has seen shares rally by 118% this year, compared to 41% for the blue-chip digital asset, leaving its market capitalization at $24.4 billion. Terming the prospective securities the “ghost pepper of ETF hot sauce,” Bloomberg’s Eric Balchunas elaborated thus on social media platform X: “these are a near-lock to be the most volatile ETFs ever seen in the U.S., [offering roughly] 20 times the volatility of the S&P 500.”

Don’t forget a cold glass of water. 

Stocks came under modest but persistent pressure following an early ramp to leave the S&P 500 some 40 basis points in the red, trimming year-to-date gains to 15% and change at the halfway point of 2024. Treasurys came for sale following last night’s inspiring redux of Lincoln versus Douglas, with the long bond jumping eight basis points to 4.51% to mark a near-three-week high. WTI crude remained slightly below $82 a barrel, gold edged lower at $2,325 an ounce, bitcoin ticked to $60,100 and the VIX remained south of 13. 

- Philip Grant

This Citi’s not big enough for the both of us. From Bloomberg:

Citigroup Inc. urged staffers not to get drawn into altercations with protesters targeting the bank’s New York headquarters, a sign that activists’ protracted campaign is beginning to wear on employees and executives alike.  Climate activists have sought to blockade the entrance to the bank’s main office since early June, with video footage showing angry scenes in the public plaza outside the building.

Citigroup’s Security and Investigative Services team is advising employees on how to handle the events, according to a memo to staff seen by Bloomberg. . .  Protesters have dubbed their campaign against Citigroup the “Summer of Heat.” On a website replete with slogans such as “Hot People Hate Wall St.” and “Eat the Rich,” organizers said protesters will be “going hard all summer long. Week after week. Month after month.”

So far, protest organizers say that roughly 200 activists have been arrested as police have lined up almost daily outside Citigroup’s headquarters. Protesters had vowed to avoid physical violence, but they also say their goal is to physically prevent employees from entering the building and doing their jobs.

Now comes the hard part. The post-2022 crypto renaissance has worked its magic in one key corner of the market, as heretofore-jilted customers of Sam Bankman-Fried’s infamous outfit FTX have enjoyed no small reversal in fortunes.  

Claimants are set to be made whole and then some, according to a liquidation plan put forth by FTX bankruptcy managers last month, a far cry from the secondary market prices of just 10 cents on the buck seen early last year on trading platform Cherokee Acquisition (the analysis “Pennies on the dollar” in the March 10, 2023 edition of Grant’s Interest Rate Observer proved a timely review of that opportunity).

Yet as The Wall Street Journal documented Monday, several institutional investors enjoying substantial paper gains are now struggling to collect their money, with existing hodlers either demanding a greater share of the winnings or refusing to part with their claims entirely, spurring a series of lawsuits. 

“We have sellers from all over the world that are interfacing with buyers and the bankruptcy court for the first time, and have never experienced a U.S. Chapter 11 case,” Andrew Glantz, chief strategy officer of crypto bankruptcy venue Xclaim, told the Journal. Call it learning by doing. 

Indeed, some crypto “degens” may soon receive a crash course in bankruptcy law. Many prospective sellers don’t have lawyers and “don’t realize that a verbal contract to sell a claim is binding under New York law, where most of these hedge fund [buyers] are based,” claims broker Thomas Braziel likewise commented to the WSJ.

Outsized, unrealized gains have likewise failed to extract other constituents from their crypto winter of discontent. Yesterday, U.S. Bankruptcy Judge John Dorsey gave FTX the green light to poll creditors on a liquidation format which would repay them in fiat currency. As Reuters reports, that plan is going over like a lead balloon in some circles, as the price of bitcoin has mooned above $60,000 from less than $17,000 when the digital bourse bought the farm in fall 2022.  

Earlier this month, a group of claimants filed a class action lawsuit contending that, since FTX never owned customer deposits, the estate must render the full, current value of their digital assets. “Customers must be made aware that the plan’s ‘full recovery’ is nothing of the sort,” the creditors groused. 

That argument overlooks the slipshod state of FTX’s books at the time of its demise, estate attorney Andy Dietderich argued at a court hearing Tuesday: “Everybody was an involuntary investor in this crazy pool of assets, and our job was to turn it to cash.” 

Current CEO John Ray III likewise told Reuters that virtually all the crypto assets under FTX’s purview are long gone, with the bourse holding just 0.1% of bitcoin and 1.2% of ethereum that customers believed it had as of fall 2022. “You cannot pay one creditor more without taking it from another creditor,” Ray explained. “Those arguing for appreciation of ‘their’ tokens would be taking money away from fellow customers who held cash, stablecoin or other crypto.” 

Multi-fold returns, manifold headaches. 

A noteworthy lurch higher in the rates complex headlined today’s session, with 2- and 30-year yields rising six and nine basis points respectively to 4.71% and 4.45%, while stocks maintained their index level inertia ahead of quarter-end with the S&P 500 snoozing through another virtually flat session (+0.12%). WTI crude remained just south of $81 a barrel, gold slipped to $2,298 per ounce, bitcoin retreated to $60,700 and the VIX ticked to 12.6. 

- Philip Grant

Stealth mode engaged, via Benzinga:

Tesla CEO Elon Musk joined Justin Timberlake‘s intoxicated driving discussion by saying the pop singer would not have been arrested had he been driving a Tesla car with its driver assistance features enabled and not a BMW.

Timberlake was arrested in Sag Harbor, New York for intoxicated driving on June 18 after he ran through a stop sign and failed to maintain his lane . . .  Following the [incident], Tesla enthusiast Omar Qazi, who goes by the username Whole Mars Catalog, took to X to say that a Tesla would not have let the singer run a stop sign or a red light, thereby helping him avoid charges. Musk agreed with the user with a short, “True.”

Four more years!  Staffers at the Federal Deposit Insurance Corporation will be obliged to report to the office only two days each week beginning July 15, The Wall Street Journal’s Andrew Ackerman relays this morning, citing a staff memo circulated Friday.  

Coming nearly a half-decade after the bug first barged in, last week’s decree represents an aspirational downshift for the banking regulator. The FDIC had previously planned to require three days per week of in-person attendance before tweaking its policy in response to “thoughtful feedback from employees and managers.”  Workers at the Dallas and Atlanta regional offices will need to visit the office only once per week, on account of space limitations (or, perhaps, employee surpluses). 

That development deftly illustrates a dim state of play in the office realm. Nationwide vacancy rates approached 20% in the first quarter, data from Moody’s show, up from 16.8% over the last three months of 2019, while delinquencies among U.S. office commercial mortgage-backed securities will reach 8.4% this year and 11% in 2025 if recently issued projections from Fitch are on the beam, up from 8.1% and 9.9% guesstimates issued earlier this year. 

“We maintain a ‘deteriorating’ outlook for the U.S. office sector until the end of 2024,” the rating agency concludes, as adverse market conditions will serve “to increase refinancing difficulties, resulting in higher loan delinquencies and more loan transfers to special servicing.”  (See the March 29 issue of Grant’s Interest Rate Observer for more on the stricken office loan sector, including instructive developments close to our home.) 

The march of technological progress, meanwhile, continues to bedevil other corners of commercial real estate. As the WSJ documents today, Brookfield Property Partners has labored to convert the bulk of its 125-mall portfolio into other residential or commercial uses, successfully redeveloping only two outdated shopping centers over the past six years with a further pair in the pipeline.  

Political red tape and longstanding leases with department stores– which often permit such anchor tenants to veto nonretail development – contribute to that halting progress. Virus-related disruptions, rising construction costs and interest rates further complicate matters. 

“Some things that might have made sense five years ago, we have to go back to the drawing board,” Brian Kingston, CEO of Brookfield’s real estate business told the Journal. “These are big, complicated projects that happen over long periods of time.” The passage of time has not been kind to that category: a $12.4 billion basket of debt securities backing 50 mall properties has slumped by 40% on average since July of 2018, KBRA Analytics finds. 

As secular shifts throw an array of CRE assets for a loop, a shaky fundamental framework further complicates life for investors.  Thus, the Financial Times reported Friday that credit agencies have “mis-rated” upwards $100 billion of debt tied to so-called single-loan deals, with at least a dozen such transactions maintaining upper-tier investment-grade ratings even with the borrowers slipping into default. 

One representative asset, 1407 Broadway in New York’s garment district, faces foreclosure as San Francisco-based owner Shorenstein Properties has failed to make a mortgage payment since July. Yet the $187 million in bonds backing the building continue to enjoy a double-A rating at Fitch.  

That eye-catching dynamic duly evokes unpleasant memories of the great financial crisis, in which a slew of triple-A-rated mortgage debt proved to be nothing of the sort. “It is. . . easily the worst example of mis-rating of major securities that is out there today,” former Moody’s credit analyst turned economics commentator Rod Dubitsky told the pink paper. “The integrity of the ratings process has improved very little” since 2008. 

Stocks ticked lower by one-third of a percent on the S&P 500 and 1.1% on the Nasdaq 100 as Nvidia extended its three-day drawdown to just under 13%. Treasurys finished little changed with the 2-year yield rising one basis point to 4.71% and the long bond settling at 4.38% from 4.39% Friday, while WTI crude pushed towards $82 a barrel, gold rebounded to $2,333 per ounce, bitcoin slumped to $59,200 and the VIX edged above 13. 

- Philip Grant

From CNBC:

Casual-dining chains are gaining customers who have grown frustrated with higher fast-food prices, Darden Restaurants CEO Rick Cardenas said on Thursday.

While Darden itself hasn’t benefited from the shift, its competitors, like Chili’s owner Brinker International and Applebee’s parent Dine Brands, have been reigniting a rivalry with their fast-food counterparts — and it seems to be working. Chili’s introduced an ad campaign that calls out the Big Mac and other fast-food burgers for their prices. Dine Brands CEO John Peyton told CNBC in May that Applebee’s has been leaning into deals to win over fast-food diners. . . 

As of May, full-service menu prices had risen 3.5% over the last 12 months, compared with a 4.5% increase for those of limited-service eateries, according to Department of Labor data. The overall consumer price index rose 3.3% in that period.

Canary Wharf in the coal mine? Thursday’s stand-pat rate decision from the Bank of England described a “finely balanced” debate among the Monetary Policy Committee over whether to trim the current 5.25% benchmark borrowing cost, the highest in 16 years. By way of response, interest rate futures moved to price greater than 50% odds of an easing move at the August 1 meeting from 32% as of Wednesday, with the projected year-end bogey slipping to five basis points to 4.78%. 

A sharp retrenchment in reported price pressures sets the stage for that prospective downshift, as headline CPI registered at a 2% annual pace last month, receding from 2.3% in April and reaching the BoE’s pined-for threshold for the first time since July 2021. 

“The U.K. has won the international race to get back to target, being the first among the euro area and the U.S. to bring headline inflation back to 2%” crowed the Resolution Foundation, a British think tank devoted to improving living standards among lower income citizens. “In fact, the U.K. currently has the lowest headline inflation rate in the G-7 barring Italy.” 

Competing price data paint a less rosy picture, with measured inflation in services advancing at a 5.7% year-over-year clip rather than the 5.3% which the BoE guesstimated a month ago.  Similarly, growth in three-month average weekly earnings registered at 5.9% from the same period last year, topping the 5.7% economist consensus. “Inflation may be back at 2%, but it might not be there for long,” Zara Nokes, global market analyst at JPMorgan Asset Management, predicted to Bloomberg. 

A potential economic slowdown further complicates matters, as the meeting minutes warned that Britain’s “labor market continues to loosen” and “business surveys. . . remain consistent with a slower pace of underlying growth,” commentary which may point toward a dovish pivot.  "The MPC has softened its focus on the hard price data, in favor of a broader macroeconomic outlook," Deutsche Bank chief U.K. economist Sanjay Raja told The Wall Street Journal. 

One thing’s for sure: easier money would help staunch the torrents of red ink gushing from the central bank’s books. After crunching the numbers spanning the start of quantitative easing in 2009 through May, Christopher Mahon, head of dynamic real return at Columbia Threadneedle, estimated to Bloomberg Tuesday that losses on underwater securities accumulated during the low-rate epoch amount to some 4.8% of U.K. gross domestic product, far above 3.3% and 1.4%-output adjusted losses for QE-era portfolios of the European Central Bank and Federal Reserve, respectively. 

The aftermath of the BoEs ill-fated shopping spree may take on a political dimension with parliamentary elections looming early next month, as British law dictates that taxpayers foot the bill for those shortfalls. That contrasts to the IOU structure on display stateside, where the Fed journals its realized operating losses in the line item “earnings remittances due to the U.S. Treasury,” rather than deducting them from the bank’s capital. 

Of course, Uncle Sam’s forgiving arrangement with its ostensibly independent central bank presents its own complications. See the analysis “Suppressed for longer” in the May 10 edition of Grant’s Interest Rate Observer for a closer look at that cozy dynamic and its potential consequences. 

Stocks settled a bit lower on the S&P 500 and moderately in the red on the tech-heavy Nasdaq 100, as Nvidia suffered an intraday reversal to settle 3.5% below Tuesday’s finish. Treasury yields ticked slightly higher across the curve as the long bond finished at 4.39%, WTI crude maintained recent momentum with a push above $81 a barrel and gold advanced to $2,358 per ounce. Bitcoin stayed below $65,000 and the VIX toggled above 13. 

- Philip Grant

From Restaurant Business Online:

McDonald’s is ending its two-year-old test of drive-thru, automated order taking (AOT) that it has conducted with IBM and plans to remove the technology from the more than 100 restaurants that have been using it.

The Chicago-based fast-food giant is ending this test without any sort of expansion, according to an email sent to franchisees on Thursday. Restaurant Business has obtained a copy of that email. But the company did not dismiss the prospect of drive-thru AI, suggesting that McDonald’s plans to find a new partner for its automated order taking efforts.

“While there have been successes to date, we feel there is an opportunity to explore voice ordering solutions more broadly,” Mason Smoot, chief restaurant officer for McDonald’s USA, said in the system message. “After a thoughtful review, McDonald’s has decided to end our current partnership with IBM on AOT and the technology will be shut off in all restaurants currently testing it no later than July 26, 2024.” 

McDonald’s has been testing drive-thru voice AI since 2021.

Sometimes, long-only is more than just a strategy. The Chinese Securities Regulatory Commission refuted social media chatter of an upswell in short selling Sunday evening, stating that a purported uptick in mainland shares borrowed for that purpose was based on faulty data, inaccurately omitting companies recently removed from local indices in a semi-annual rebalancing.  Only firms listed in China’s major equity gauges are eligible for such downside bets.  

Indeed, the outstanding value of shorted stocks fell to a four-year low of RMB 33.6 billion ($4.6 billion) as of Friday per data from Bloomberg, down 81% from its September 2021 high-water mark. Yet with the benchmark CSI 300 off 4% over the past month following a 16% post-January bounce, regulators evidently looked to halt nascent bearish momentum. 

“Going forward, the CSRC will fully evaluate and fine-tune the rules on short-selling and strengthen counter-cyclical adjustment,” the mandarin-speaking mandarins promised. “At the same time, we will step up oversight and severely punish irregularities.”

Such threats of heavy-handed discipline for wayward bears are not confined to the Middle Kingdom. Late last week, South Korean regulators extended a market-wide ban on short selling by nine months through March of 2025, as Seoul works “to establish an electronic system to prevent naked short-selling and relieve concerns about such practices hindering fair pricing in the securities market” per a Financial Services Commission communique.  

The ban, initially enacted in November to combat so-called naked shorting (i.e., selling unowned shares without first borrowing them), has proven particularly popular among South Korea’s “politically influential” cohort of individual investors, notes Bloomberg. To that end, perhaps, the FSC likewise stiffened financial penalties for illegal shorting to as high as six times any profits made from a prior five-fold cap, while offenders who clear KRW 5 billion ($3.6 million) via illicit activity now face life imprisonment instead of a maximum 30-year prison sentence.

Mr. Market-meted punishment is sufficient deterrence for some Western investors. Thus, the Financial Times reported earlier this month that hedge funds have dialed back their downside bets in the U.K. after several firms targeted by short sellers received buyout proposals. London’s FTSE 100 Index trades at less than 12 times projected earnings according to Bloomberg, far below 22 times forward multiple for the S&P 500. 

“Shorting any U.K. mid-cap is insane, literally insane,” a short-selling specialist fund manager told the pink paper. “The [valuations] are just so low in the vast majority of cases that a $2 billion U.K. company is peanuts for any mid-sized American [buyer].” The deal value of M&A featuring a U.K.-based target is running some 84% ahead of last year’s pace, data from London Stock Exchange Group show.

Stateside, fatter price tags do little to entice the bear crowd from hibernation, as median short interest among S&P 500 components sits at just 1.7%, near its lowest in upwards of 20 years according to Goldman Sachs, while the universe of short-biased hedge funds tracked by industry group HFR has shrunk to 14 from 54 such outfits as of 2008.  Former Kynikos Associates boss Jim Chanos, who recently converted his fund to a family office after assets dwindled below $200 million from $6 billion plus during the financial crisis, summed it up to Bloomberg on June 4: “Investors – primarily institutional investors – have just given up on the fact that there’s going to be excess returns on the short side.” 

No life imprisonment necessary. 

A staid start to the week dovetailed into another bull party, as stocks turned on the jets around lunchtime to leave the S&P 500 and Nasdaq 100 up by 0.8% and 1.2%, respectively, though Treasurys pulled back from their scorching rally with the two-year note snapping to 4.75% from 4.67% and the long bond rising six basis points to 4.4%.  WTI crude climbed towards $80 a barrel, gold retrenched to $2,319 an ounce, bitcoin stayed below $67,000 and the VIX logged its latest sub 13 finish.

- Philip Grant