From the Associated Press:

A Miami jury decided that Elon Musk’s car company Tesla was partly responsible for a deadly crash in Florida involving its Autopilot driver assist technology and must pay the victims more than $200 million in punitive damages.

The federal jury held that Tesla bore significant responsibility because its technology failed and that not all the blame can be put on a reckless driver, even one who admitted he was distracted by his cell phone before hitting a young couple out gazing at the stars. . .

The decision ends a four-year long case remarkable not just in its outcome but that it even made it to trial. Many similar cases against Tesla have been dismissed and, when that didn’t happen, settled by the company to avoid the spotlight of a trial. “This will open the floodgates,” said Miguel Custodio, a car crash lawyer not involved in the Tesla case. “It will embolden a lot of people to come to court.”

It’s a speculative-credit bonanza. Freewheeling conditions in the primary market pushed leveraged loan activity to new heights in July, with domestic new issuance reaching $223.2 billion. That’s the largest one-month total on record, comfortably topping the prior $206 billion peak established in January.  

One instructive development: Feverish demand helped software firm Datasite International price two loans in less than a month to fund a pair of acquisitions, with pricing on the second deal on July 23 matching the first even after Moody’s Analytics downgraded the firm to B3 from B2 (equivalent to single-B-minus from single-B) during the interim, dubbing its roll-up strategy “more aggressive than anticipated.”

Within the high-yield bond category, supply clocked in at $35 billion, the busiest July since at least 2006. Last month, the triple-C-rated portion of Bloomberg’s junk bond gauge posted a meaty 1.47% return, compared to sub 0.5% advances for the single- and double-B-rated categories.

“I haven’t seen a market quite like this post the Great Financial Crisis,” Jon Poglitsch, managing director at Sycamore Tree Capital Partners, marveled to Bloomberg Wednesday. There’s a “grab for spread where anyone can find it,” he noted.

Blue-sky financial conditions make for a stark contrast with today’s cloudy economic backdrop, as still sharply elevated borrowing costs from their post-2008 norm and tariff-related risks to growth, inflation and profit margins pose material threats to a growing slate of vulnerable borrowers.

Thus, Moody’s distressed debt watch – composed of firms rated B3 and below alongside a negative outlook – reached 17.4% of the speculative grade population as of June 30, up 150 basis points over the prior three months. The ratings agency likewise issued 3.3 downgrades for every upgrade during the second quarter, the worst ratio since 2022, while corporate defaults jumped to 21 firms and $27 billion in aggregate debt.  That compares to 15 defaults totaling $15 billion in the first quarter.

The trailing 12-month default rates stood at 5.9% as of June 30, well higher than the 3.1% Moody’s guesstimate at this time a year ago.  “We project the default rate to fall [towards] 4.1% under our base case scenario” at year end, analysts at the firm wrote Tuesday. “However, even a modest adverse shock could drive the rate significantly higher.”

Such an outcome would pose major headaches for today’s intrepid creditor class. The average recovery rate for first-lien term loans in bankruptcy reached a record low 46% last year, down from more than 90% in 2011 and more than 70% as recently as 2022, while lenders recouped 61 cents on the dollar from defaulted first-lien loans across both bankruptcy and distressed exchanges, compared to 73 cents on average dating to 1987.

“Loose covenants help borrowers postpone hard defaults (such as bankruptcies or missed debt payments) but erode a company’s value by the time a bankruptcy is inevitable,” Moody’s pointed out in April. “In some cases, weaker credit protections enable debt issuers and their private equity sponsors to execute complex debt exchanges that pit one lender group against another, leading to poor recovery outcomes in re-default scenarios for some of these lenders.”

Forewarned is forearmed. See the analysis “Clever lawyers’ field day” in the brand-new edition of Grant’s Interest Rate Observer dated Aug. 1 for more on the rise of so-called liability management exercises.   

Stocks were hammered by 1.6% on the S&P 500, extending the bearish price action beginning with yesterday’s downside reversal on the blue-chip gauge.

Mr. Market provided his own “rate cut” in response to today’s soft July payrolls report, as two-year yields dropped an even 25 basis points to 3.69%  (the long bond declined eight basis points to 4.81%).  WTI crude retreated to $67 a barrel, gold jumped nearly 2% to $3,359 per ounce, bitcoin dropped 3% to $113,000 and change while the VIX ripped to 20.5, up nearly four points on the session.  

- Philip Grant

From Reuters:

Cuba's private sector is accounting for more retail sales by value on the Communist-run island than the state for the first time since the years following Fidel Castro's 1959 revolution, new government data shows.

Preliminary figures from the National Statistics Office published last week indicate the "non-state" sector was responsible for 55% of retail sales of goods and services in 2024, up from 44% in 2023. The figures exclude public utilities. . .

In tandem, the state-run economy has shrunk, contracting by 11% over the last five years and marked by frequent blackouts, goods shortages, and high inflation.

It’s a nation of homebodies: The U.S. housing market has come off the boil following its torrid Covid-era runup, as S&P CoreLogic Case-Shiller’s national price gauge rose by only 2.3% year-over-year in May, data released today show. That’s down from a 2.7% increase in April to mark the fourth straight sequential downtick, in turn representing a fraction of the 17% average annual growth rate logged from December 2020 through September 2022.  

Those bounding gains, in tandem with the sharp post-pandemic rise in borrowing costs, paints a daunting affordability picture. The share of median family income needed for monthly principal and interest payments on the median-priced, existing single-family home stood at 25.7% in May per the National Association of Realtors, up from 16.4% six years prior. Accordingly, existing home sales ebbed to a 3.93 million seasonally-adjusted annual rate in June, the NAR finds, far below the 5.22 million average seen since 1998 and approaching the 27-plus-year low logged in 2010.

“The housing market is stuck, with both prospective buyers and sellers increasingly concerned about the economy and their own personal financial situations,” Lisa Sturtevant, chief economist at data firm Bright MLS, told Bloomberg.

Though sticker shock continues to directly inform today’s housing market stalemate, that’s not to say that consumers aren’t up for shelling out cash to spruce up their current dwelling. Earlier this month Jefferies analysts led by Jonathan Matuszewski found that website visits to sampled home remodeling service providers jumped by nearly 50% year-over-year during the second quarter.  As recently as the final three months of last year, that gauge sat in negative territory.  

Outstanding home equity lines of credit, meanwhile, ticked up to $406.5 billion during the first quarter according to the Federal Reserve, up 23% over the past three years to reach its highest since summer 2019. Mortgage borrowers withdrew nearly $25 billion in equity via second-lien credit lines during the first three months of this year, Jefferies relays, up 22% from the same period last year to mark the largest first quarter borrowing spree since 2008.

Those developments may augur bullish tidings for industry mainstays Home Depot and Lowe’s, Matuszewski et al. posit, finding thus: “In prior periods where we observed homeowners increasingly tapping their home equity, HD and LOW comparable sales accelerated to between mid-single digits and low double-digits, and price-to-earnings multiples increased by five to nine turns.”

Jefferies’ eye-catching analysis marks a break with Mr. Market, as the duo has materially lagged the S&P 500 over the past 12 months with HD generating a 6.5% return and Lowe’s shareholders losing 2.5%, compared to the blue-chip gauge’s 18% advance. Though not exactly discarded bargains, HD’s forward P/E ratio has contracted to 25 from near 27 since last fall while Lowe’s changes hands at 18.5 times its Bloomberg-compiled sell-side earnings consensus, down four turns from mid-October.  Over that same stretch, the S&P 500’s forward earnings multiple has expanded to 22.4 times from 21.9 according to FactSet.  

Stocks came under modest pressure after erasing early gains, with the S&P 500 logging a 0.3% decline, while Treasurys caught a strong bid ahead of tomorrows Fed rate decision with two-year yields dropping five basis points to 3.86% and the long bond ebbing to 4.86% from 4.96% Monday. WTI crude remained on the front foot at more than $69 a barrel, gold bounced to $3,325 per ounce, bitcoin ticked slightly lower at $117,500 and the VIX rose to 16.

- Philip Grant

That’s what dogs are for. From TechCrunch:

ChatGPT users may want to think twice before turning to their artificial intelligence app for therapy or other kinds of emotional support. According to OpenAI CEO Sam Altman, the AI industry hasn’t yet figured out how to protect user privacy when it comes to these more sensitive conversations, because there’s no doctor-patient confidentiality when your doc is an AI.

The exec made these comments on a recent episode of Theo Von’s podcast, This Past Weekend w/ Theo Von. . .

“People talk about the most personal sh** in their lives to ChatGPT,” Altman said. “People use it — young people, especially, use it — as a therapist, a life coach; having these relationship problems and [asking] ‘what should I do?’ And right now, if you talk to a therapist or a lawyer or a doctor about those problems, there’s legal privilege for it. There’s doctor-patient confidentiality, there’s legal confidentiality, whatever. And we haven’t figured that out yet for when you talk to ChatGPT.”

Relationship under construction: “The Federal Reserve was honored to welcome the president yesterday for a visit to our historic headquarters,” commented a Fed flack Friday, adding thus with respect to the much-ballyhooed renovation of the central bank’s Washington headquarters: “We are grateful for the president’s encouragement to complete this important project.”   

Ever the gracious guest, President Trump in turn backed off his recent calls to remove Fed chair Jerome Powell prior to the end of his term next May: “To do that is a big move, and I just don’t think it’s necessary.”

Thursday’s visit – the first by a sitting Commander-in-Chief in nearly 20 years – featured a comically awkward, on-camera debate between the hardhat-wearing Trump and Powell over cost overruns tied to the Marriner S. Eccles and adjacent 1951 Constitution Avenue building refurbishments.

Ultimately, however, Trump struck a conciliatory tone regarding the project: “Look, there’s always Monday morning quarterbacks – I don’t want to be that. I want to help them get it finished.”  The projected price tag now stands at $2.5 billion per The Wall Street Journal, up some 32% over the prior two years.

Ironically, the potent post-Covid inflationary impulse that erupted in the wake of torrents of fiscal and monetary stimulus has helped fan the political flames now bedeviling Powell et al. The Mortenson Construction Cost Index, which tracks nonresidential input prices across eight major metropolitan areas, ballooned by 41% from 2019 through the first quarter of this year.  That compares to a 26% increase in headline CPI over the six years through March.

Of course, those price pressures are yesterday’s news in the White House, with E-Z money remaining front of mind for the former leveraged real estate speculator. “I’d love him to lower interest rates,” Trump reiterated yesterday with regards to Powell. “Other than that, what can I tell you?”

Large and growing swaths of the populace beg to differ, as measured inflation has remained stuck above the Fed’ self-imposed 2% annual target for more than 50 months alongside the looming specter of further tariff-induced increases. Thus, 64% of respondents to a CBS/YouGov poll conducted this week expressed disapproval with Trump’s handling of inflation, up from 61% last month and 54% in March.  The president’s overall approval rating likewise slipped to 42% from 51% four months ago.

Conversely, Trump’s unwavering focus on lower borrowing costs has tickled Mr. Market, with stocks back at record highs, corporate credit spreads near their tightest of the post-Lehman Brothers era and speculative assets such as cryptocurrencies lunar-bound. Interest rate futures point to a 3.93% Fed funds rate by year-end, compared to today’s 4.25% to 4.5% range, with a further retreat towards 3.25% by fall 2026.  

With the Fed having already eased rates by one full percentage point last fall, an equivalent downshift would be one for the record books, barring an unwelcome economic surprise. “History suggests that 200 [basis points] of cuts has almost always required a recession,” writes Jim Reid, global head of macro and thematic research at Deutsche Bank.

Over to you, Don and Jay.  

Stocks levitated once more to the tune of 0.4% on the S&P 500, wrapping up the week with a tidy 1.3% advance to leave the blue-chip gauge with a gaudy 29% total return since April 8.  The Treasury curve flattened with 30-year yields dipping four basis points to 4.92% while the two-year note held at 3.91%.  WTI crude dropped to $65 a barrel, gold remained under pressure at $3,339 per ounce, bitcoin retreated to $117,000 and the VIX sank below 15.

- Philip Grant

The (search) engine light is on: artificial intelligence platforms are carving out a growing piece of the internet query pie, with large language models such as ChatGPT and Perplexity attaining a 5.6% market share across U.S. desktop browsers last month according to The Wall Street Journal, citing market intelligence firm Datos.  That’s up more than 100% from June 2024 and more than fourfold from the 1.3% figure seen early last year.

A subset of early adopters has leaned headlong into the nascent technology, Datos finds, as those who started using LLMs by April 2024 now utilize AI for 40% of their searches, up from 24% one year ago. Conversely, the amount of time spent on traditional search engines across the globe ebbed by 3% over the 12 months through April, research firm Sensor Tower finds, with early LLM adopters easing their use of legacy tools at twice that rate.

Of course, a supersonic boom in data center construction helps bring the AI revolution to the fore, with Oracle and OpenAI announcing plans Wednesday to build out a further 4.5 gigawatts of domestic capacity to help develop the sprawling Stargate project, one week after Meta boss Mark Zuckerberg detailed plans for a new 5GW facility in Louisiana.  For context, total U.S. capacity registered at less than 36GW at the start of this year (see the Jan. 31, March 28, June 6 June 20 and July 4 editions of Grant’s Interest Rate Observer for more on the potentially seismic attendant investment implications and risks).

One thing's for sure: that mega-trend does no favors for American wallets. Earlier this week, electric grid operator PJM, which serves 13 states and Washington, D.C. (including North Virginia’s “data center alley”), announced that its annual capacity auction cleared at $329.17 per megawatt-day, up a further 22% year-over-year following an 833% spike from the auction conducted in summer 2023.

“It literally tells you we are out of generation,” Sean Kelly, CEO of power forecasting firm Amperon Holdings, tells Bloomberg. “It’s good for traders, it’s good for asset owners, it is not good for consumers.” National electricity prices rose 5.8% over 12 months through June, according to the Department of Labor’s latest CPI figures.

Considering the political and financial stakes, it is no surprise that AI industry players train their collective attention on the nation’s capital.  More than 500 such organizations directed lobbying efforts at Congress and the White House over the first six months of the year, the Financial Times relays, while OpenAI and Anthropic forked over a combined $2 million in second quarter lobbying outlays, up from $800,000 in the same period last year.

Will those efforts bear fruit?  A Tuesday bulletin from CNBC details a type of progress:

Sen. Mike Lee, R-Utah, on Tuesday reportedly shared and then hastily deleted a fake, apparently AI-generated letter purporting to show Jerome Powell resigning as chairman of the Federal Reserve.

The phony letter — addressed to “The President” — featured a garbled Fed seal with non-English characters and a slightly misshapen depiction of an eagle, as well as some unusual text spacing.

“After much reflection, I have decided to resign from my position as Chair of the Board of governors of the Federal Reserve System, effective at the close of business today, July 22, 2025,” the letter read.

It was posted on Lee’s verified personal X account, @BasedMikeLee, according to journalists at Politico who took screenshots of the post before it was deleted. “Powell’s out!” Lee wrote in between two emojis of flashing red sirens, the screenshots show.

Powell has not resigned.

Headlines touting trade-related progress helped stocks stage another strong push higher, with the S&P 500 accelerating into the close to wrap up at fresh highs with a near 1% advance  Treasurys gave back some recent gains as 2- and 30-year yields each rose five basis points to 3.88% and 4.95%, respectively, while WTI crude stayed at $65 a barrel and gold pulled back to $3,390 per ounce. Bitcoin ebbed below $118,000 while the VIX retreated below 16.

- Philip Grant

From Fox News:

Rep. Anna Paulina Luna, R-Fla., is referring Federal Reserve Chair Jerome Powell to the Department of Justice (DOJ) for criminal charges, accusing him of two specific instances of lying under oath. . .

"On June 25, 2025, Chairman Powell provided testimony under oath before the U.S. Senate Committee on Banking, Housing, and Urban Affairs regarding the renovation of the Federal Reserve’s Eccles Building. In his statements, he made several materially false claims," Luna's letter said.

And an excerpted press release from the Senate Committee on Banking, Housing and Urban Affairs:

U.S. Senator Elizabeth Warren (D-Mass), Ranking Member of the Senate Banking, Housing, and Urban Affairs Committee, wrote to Federal Housing Finance Agency (FHFA) Director Bill Pulte about his abnormal behavior directed at Fed Chair Jerome Powell. . .

 The Ranking Member noted that since the beginning of July alone, Director Pulte has posted or reposted more than 100 times on X about Chair Powell. The Ranking Member listed Pulte’s 15 posts about Chair Powell on July 16th alone.

Washington, D.C.’s recently concluded “crypto week” wrapped up with a fitting bull-market milestone: the asset class reached an aggregate $4 trillion valuation Friday in tandem with the passage of the GENIUS Act establishing a regulatory framework for stablecoins.  

Notably, so-called altcoins drove the latest lunar propulsion, with bitcoin dominance – meaning its share of digital market value – slipping below 60% from 65% in late June per data from Coinmarketcap.com.  The price of dogecoin, meanwhile, jumped 9% over the 24 hours through Monday morning, pushing its market cap north of $41 billion, while industry second fiddle ethereum racked up a 25% gain during the past week, leaving the ducats at their best levels since early 2022 at a $460 billion price tag.  

“Some will credit the stablecoin and [financial asset tokenization] narrative,” Augustine Fan, head of insights at digital trading firm SignalPlus, told CoinDesk. “But we think it’s just good old-fashioned risk-on spillover. Most TradFi players are already fully positioned on bitcoin.”

Indeed, the corporate crypto adoption frenzy pioneered by Strategy boss and bitcoin evangelist Michael Saylor continues to broaden beyond the pre-eminent digital ducat.  

Thus, Monday brought word that new entrant the Ether Machine will list on the Nasdaq via a merger with special purpose acquisition company Dynamix Corp., with plans to accumulate upwards of $1.5 billion of the titular tokens. Backers will include digital exchanges Kraken and Blockchain.com, with Ether Machine co-founder Andrew Keys set to provide a $645 million anchor investment. “We’ve essentially amassed the Avengers of Ethereum,” Keys told The Wall Street Journal.

The deal is scheduled to close in the fourth quarter pending shareholder approval, though they certainly seemed to approve Monday, as Dynamix shares jumped nearly 50% at this morning’s cash equity open.

Peer Bitmine Immersion Technologies (ticker: BMNR) likewise remains the Apple of Mr. Market’s eye, with shares enjoying an 828%, three-week moonshot after announcing the adoption of an ethereum Treasury strategy under the auspices of Fundstrat co-founder Tom Lee. That move may be just the beginning if the Wall Street strategist’s bulled-up forecast comes to fruition: Gazing into his crystal ball, Lee told CoinDesk that ether is poised to reach the $10,000 to $15,000 range at or before year-end, compared to today’s perch just below $3,800.

Instructively, the great crypto levitation has already underpinned luxury consumption. The Financial Times relays today that Flexjet has completed an $800 million funding round valuing the private aviation firm at $4 billion, marking the niche industry’s largest ever capital raise according to Jefferies. Flexjet, which logged $2.6 billion in revenues during the 12 months through September, up over 50% from the same period  three years earlier, “seeks to expand its fleet in response to demand from technology and crypto entrepreneurs,” the pink paper notes.

Take a bow, Dr. Bernanke: it’s your wealth effect in action.

Stocks lost some altitude late in the session but still managed modestly green finishes on the S&P 500 and Nasdaq, while Treasurys caught a bull flattening bid with the long bond dipping six basis points to 4.94% and two-year yields retreating to 3.85% from 3.88%. WTI crude slipped below $66 a barrel, gold ripped to $3,399, bitcoin ebbed to $117,000 and the VIX bounced toward 17.

- Philip Grant

From CNBC:

Wall Street is lovin’ McDonald’s newest menu item. Analysts at several firms have this week told clients that the return of the Snack Wrap — the fan favorite that was originally discontinued in 2016 — has been positive for the fast food giant. . .

The third quarter “has gotten off to a strong start helped by the relaunch of Snack Wrap,” Evercore ISI analyst David Palmer wrote to clients in a Thursday note. . . Barclays also said it expects the wrap to help lift traffic, a factor that prompted analyst Jeffrey Bernstein to declare McDonald’s his top-pick stock among quick-service restaurants. . .

“We think excitement for Snack Wraps ... positively contributed to brand buzz/momentum to start 3Q,” Greg Badishkanian, head of Wolfe’s consumer team, wrote to clients on Tuesday.

Four score! Nvidia’s mind-boggling bull run reached a new milestone last week, with Jensen Huang’s outfit becoming the first company to achieve a $4 trillion market capitalization.  The 32-year-old firm, which first breached the $2 trillion threshold in February 2024 and $3 trillion fourth months later, takes the global corporate league tables’ top spot after Apple and Microsoft first achieved the $3 trillion bogey in June 2023 and January 2024, respectively.

As every investor is well aware, big tech has played a starring role in the ongoing bull stampede. To wit: the information technology sector commands a 33.8% weighting in the market cap-weighted S&P 500, approaching the 34.8% logged in March 2000.   Notably, that group does not include consumer discretionary-designated Amazon.com and Tesla, which represent 4% and 1.7%, respectively. Nvidia alone commands a 7.9% share, exceeding the combined weightings of the energy, utilities and materials sectors.

Today’s top-heavy, tech-centric stock market composition has thrown broadly diversified investors for a loop in recent years, as only 30% of Russell 1000 components outperformed the benchmark in 2023 and 2024 per an April analysis from Peter Stournaras, co-head of global equity portfolio management at T. Rowe Price.   

Stournaras likewise finds that, between 2019 and 2024, not owning the five largest members of that index would have hampered performance by more than 500 basis points per annum, with that handicap surpassing 700 basis points in four of those years. Tellingly, perhaps, AllianceBernstein determined last month that 68% of actively-managed U.S. large cap growth equity portfolios outperformed their benchmarks during the first quarter, a period in which Bloomberg’s Magnificent 7 gauge dipped 15%.

More broadly, mega-cap technology’s stellar post-Lehman Brothers performance leaves the largest 10 S&P 500 firms with a collective 37% weight, the largest share in 50 years per data from the Hartford Funds. Yet such top-heavy dynamics often presage their own wobbles. The firm finds that since 1970, a combined top 10 S&P 500 weighting of greater than 23.4% has augured subsequent five-year outperformance from the other 490 components in 91% of instances.

Then, too, recent bear markets have conferred particular pain on the best and brightest, with the top 10 members suffering outsized drawdowns during the dot-com aftermath, Great Financial Crisis and Covid crucible.

Where to look for potentially promising positions beyond the purview of Silicon Valley? See the June 20 edition of Grant’s Interest Rate Observer for a look at one investor focused on firms valued at $10 billion and below who has generated 17% average net returns over the past 13 years, featuring a pair of their picks-to-click.

Reserve Bank credit remains at $6.614 trillion following a stand-pat week.  The Fed’s portfolio of interest-bearing assets is down $18 billion over the past month, and 25.9% from its early 2022 peak.

Stocks enjoyed another strong advance with the S&P 500 and Nasdaq 100 racking up 0.5% and 0.8% gains, respectively, while two-year Treasury yields rose three basis points to 3.91% with the long bond holding just above 5%.  WTI crude ticked toward $68 a barrel, gold ebbed to $3,339 per ounce, bitcoin hovered at $19,300 and the VIX settled south of 17.

- Philip Grant

From CNBC:

Over-inflated home prices, high mortgage rates, rising supply and falling demand are all joining forces to cool the nation’s housing market.

Annual home price growth in June was just 1.3%, down from 1.6% growth in May and the slowest rate in two years, according to ICE [Mortgage Technology].

Nearly one third of the largest 100 markets are now showing annual price declines of at least a full percentage point from recent highs, and the trend suggests more markets will do the same. Single family home prices were up 1.6%, while condominium prices were down 1.4% nationally. Inventory has been rising steadily over the past year, up 29% in June compared with the same month last year. The gains, however, began slowing this past spring.

We are so back:  Business is booming across speculative-grade credit, as Monday saw the launch of 19 leveraged loan deals worth a combined $24 billion, the largest single-session output in nearly six months.  That barrage directly follows the busiest week since January and coincides with fresh year-to-date highs for the Bloomberg loan index Friday at just over 97 cents on the dollar.  

Fresh junk bond supply, meanwhile, topped $37 billion in June, the busiest single month since September 2021, with average daily trading volumes on the secondary market reaching a record $17.1 billion per data from JPMorgan.  Option-adjusted spreads on the ICE BofA U.S. High Yield Index remain south of 300 basis points,  compared to an average perch near 500 basis points over the past 20 years.

Yet cooling corporate fundamentals make for an unwieldy pairing with the bond market’s risk-happy stance.  The ratio of rating agency upgrades to downgrades within high-yield stands at just 30.6% so far in July, down from 34.6% in the year-to-date and 40% across 2024. In turn, some 9% of worldwide junk bond and leveraged loan borrowers are opting to service their obligations with additional debt rather than cash, JPMorgan Asset Management’s head of market strategy, Oksana Aronov, relayed on a Bloomberg-hosted podcast last week. That compares to a 4% share of payment-in-kind seen in 2020.

Any lasting uptick in distress could prove painful for lenders, as softer covenants alongside the rising preponderance of so-called liability management exercises have helped erode recovery rates on defaulted bonds and loans toward 20 and 40 cents on the dollar respectively, from their long-term averages of 40 and 70 cents. “There’s value in shorts and credit protection,” Aronov said. Default swaps are “very undervalued today because of the complacency in the market.”

A bitcoin breakout to fresh highs near $120,000 headlined another sleepy summer session, as the S&P 500 settled higher by 0.2% and Treasurys finished little changed across the curve. WTI crude ebbed below $67 a barrel, gold ticked to $3,345 per ounce and the VIX climbed back above 17.

- Philip Grant

We’ve got boots on the ground: The European Union is set to admonish the Italian government for purported interference with UniCredit SpA’s planned takeover of peer Banco BPM, Bloomberg reported Tuesday, as Brussels looks to overrule the member state’s “harsh conditions” on a combination between two of its four largest lenders by market capitalization.

Forthcoming EU action “could eventually pave the way for an order for the Italian government to withdraw the terms it imposed” on UniCredit’s approach, Bloomberg relays. For their part, “Italian officials were uncharacteristically quiet Tuesday,” indicating “that the move surprised most politicians in Rome.”  That prospective tie-up would continue a tidal wave of consolidation within Italy’s banking system, as five major mergers have been announced since November.

***

Against that volatile, dynamic backdrop, one niche player has quietly enjoyed smooth sailing, with BFF Bank SpA (ticker: BFF IM) returning 32% in dollar terms since a bullish analysis in the Dec. 20 edition of Grant’s Interest Rate Observer. The S&P 500 is up 6.5% over that stretch.  

No ordinary borrow-short, lend-long outfit, BFF was founded in 1985 by a coalition of large pharmaceutical companies to collect accounts receivable owed by the Italian government.  Four decades later, factoring receivables delivered 57% of first quarter revenues, while payments, custodial and deposit services and interest income – primarily from its government bond portfolio – accounted for the rest.   

“BFF isn’t run like a typical Italian company,” Vitaliy Katsenelson, CEO of Investment Management Associates, advised Grant’s late last year. “Their internal language is English, and they have a hardworking culture.” Investor-aligned management also features in the bull case, as long-tenured CEO Massimiliano Belingheri, who has held his position since 2013, remains BFFs largest shareholder with a 5.8% stake.

Often slow-paying, Italy (which accounts for 62% of its factoring book) and other EU governments eventually fork over what is due, so credit losses remain negligible. Yet a spring 2024 regulatory shift helped throw shareholders for a loop, as the Bank of Italy began requiring the firm to mark any paper past due by at least 180 days as non-performing, with that rule applying to any outstanding invoice from a delinquent borrower.  Previously BFF was permitted to classify such past-due claims as performing, provided there was some measurable progress towards collecting payment. 

Consequently, problem assets registered €1.82 billion as of March 31 compared to €324 million in the same period in 2024.  With capital requirements commensurately rising sharply, the company was obliged to suspend its dividend last May, sending shares lower by a quick 34%.

By way of response, BFF tweaked its accounting practices, recognizing upfront a greater share of interest it earns on late payments to burnish reserves. The company likewise managed to whittle down past-due accounts by 5% over the three months through March, while growing its Italian factoring volumes by 10% year-over-year.  

As a result, the common equity tier 1 capital (CET1) ratio jumped 143 basis points on a sequential basis to 13.7% in the first quarter, topping the 13.5%  seen right before the Bank of Italy’s stringent new rules came into effect. Notably, the current figure comfortably tops management’s prior 12% bogey at which they would distribute all earnings to shareholders.  “We expect an acceleration in [past-due] reductions in the coming quarters,” analysts at Deutsche Bank predicted on June 19, noting that a 50% downshift in that backlog could push CET1 to a hefty 17%.

Might a regulatory green light for renewed shareholder payouts be on the horizon?  “We expect that the bank of Italy’s ban on dividend distribution will be removed sooner than later,” DB concluded.

Reserve Bank credit stands at $6.613 trillion; little changed over the past week.  The  Fed’s portfolio of interest-bearing assets is down $14 billion from this time last month and sits 25.8% below its early 2022 peak.

Stocks fluttered higher by 0.3% on the S&P 500 to confer fresh highs on that blue-chip gauge, with bitcoin ascending to its own record north of $113,000. Treasurys finished little changed across the curve, while WTI crude ebbed below $67 a barrel, gold rose to $3,324 per ounce and the VIX remained south of 16.

- Philip Grant