The Wall Street Journal - 04.03.2020

B14| Wednesday, March 4, 2020 ** THE WALL STREET JOURNAL.

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FINANCIAL ANALYSIS & COMMENTARY

Rate Cuts No Miracle Cure

Fed can support the economy in the fight against virus but can’t lead it

Selloff Reveals

Hidden Mechanics of

Financial Markets

Gold, yen among assets that have performed

unexpectedly, showing change in structures

You only learn who has been
swimming naked when the tide
goes out, Warren Buffett famously
wrote in a shareholder letter. As
volatility has soared during the
past two weeks, some asset classes
have started to show a little more
skin, and interesting wrinkles.
Perhaps the most notable anom-
aly of the latest selloff has been
gold, which had been enjoying a
strong year. As bond yields tum-
bled and equities plunged last
week, the price of the supposed
haven didn’t rally. Rather, it fell.
Forced selling is at the heart of
most explanations for why the
gold price slipped. As investors
face margin calls for other invest-
ments, they sell gold to cover
themselves.
A similar theory advanced by
Cantor Fitzgerald analysts is that
the precious metal may be sold by
central banks in emerging mar-
kets, which use the dollars re-
ceived to defend their currencies.
Oddities are emerging in the
foreign-exchange market, too. The
Japanese yen is often described as
a haven, based on expectations
that Japanese investors repatriate
their overseas profits and even liq-
uidate foreign assets during mar-
ket tremors.

Yield on the 10-year Treasury note

Source: Tullett Prebon

3.5

0

0.5

1.0

1.5

2.0

2.5

3.0

%

2018 ’19 ’20

Banks’ cross-border trading
businesses actually improved as
tariffs went up and trade wars
loomed. The novel coronavirus
won’t be so accommodating.
During the protracted U.S.-China
trade roller coaster over the past
two years, which saw disruptions
in the usual cross-border patterns,
the business of providing loans and
other financing for overseas com-
merce enjoyed its best stretch in
years. The biggest banks’ trade-fi-
nance revenue grew over 2018 and
2019, according to new figures
from industry tracker Coalition.
That compares with a decline of
more than 20% from 2014 to 2017.
The threat of a trade war coun-
terintuitively led to things like
cross-border operators paying
their banks for a form of insurance
that trading partners would pay
up and also for help financing new
trade routes. That was a nice
countervailing tailwind for banks
at a time when interest rates were
falling—sometimes going nega-
tive—and when corporate clients
were cautious about big new in-
vestments.
By contrast, the disruptions to
cross-border trade and supply
chains stemming from global ef-
forts to halt the spread of the new
coronavirus are likely to hurt the
trade-finance businesses. Trade
isn’t rerouting or becoming more
expensive—it just may not happen.
For example, the largest U.S. gate-
way for seaborne China imports is
estimating a 25% drop in volume
for February. Plunging oil prices
also are linked to lower values for
letters of credit. Coalition research
director Eric Li says he believes
that in the aggregate, the biggest
trade banks are likely preparing for
a decline of 5% to 10% in trade-fi-
nance revenue in the first quarter.
It is a big pool of fees for the big-

gest banks, at $5.9 billion in 2019.

Exposure to trade-finance reve-

nue is heavily weighted toward Eu-

ropean banks. As of the end of

2018, the top tier of trade-finance

banks wereCitigroup,HSBC Hold-

ings,BNP ParibasandCrédit Ag-

ricole, according to Coalition’s

league-table ranking. In the second

tier wereDeutsche Bankand

Standard Chartered.

What may be a more acute situ-

ation is if banks sharply limit the

provision of trade financing to cli-

ents, such as buying invoices as a

way to provide clients with cash to

keep operating. The World Trade

Organization estimates 80% of

global trade requires a credit or

guarantee to take place. A situa-

tion in which banks are protecting

their balance sheets or can’t un-

load that credit to investors would

deprive the global supply chain of

vital fuel.

This is yet another reason that

anticipation of a pandemic, and not

just a pandemic itself, is something

for markets to consider.

—Telis Demos

Trade-finance revenue at the

biggest global transaction banks

Source: Coalition

$8

0

2

4

6

billion

2014 ’15 ’16 ’17 ’18 ’19

Sometimes having the world’s

largest bank account still isn’t

enough.

Alphabet, Google’s parent com-

pany, sits on a little more than

$115 billion of cash net of debt,

having overtakenApple’s hoard

last year. But the internet titan ap-

parently still needs a little help

from its friends. The company’s

Waymo self-driving car venture

announced its first outside inves-

tors on Monday, raising $2.25 bil-

lion from a group led by private-

equity firm Silver Lake.

The move was billed as a testa-

ment to Alphabet’s unusual struc-

ture. Google reorganized itself to

have a parent company in 2015

with the stated purpose of separat-

ing its numerous “other bets” from

its core internet business. The idea

was that other bets that were suc-

cessful could become self-sustain-

ing. Chief Financial Officer Ruth

Porat told a Morgan Stanley con-

ference on Monday that the com-

autonomous miles there last

year—75% more than the next-

highest mileage belonging toGen-

eral Motors’ Cruise venture.

Yet it is clear that autonomous

cars will take years to reach the

market. The best of the autono-

mous systems being tested in Cali-

fornia still disengaged at least

once every 18,000 miles. Setbacks

include fatal accidents involving

Tesla’s autopilot feature, often

billed by its fans as a semiautono-

mous system, and one involving

Uber’s self-driving project. Bern-

stein’s Stacy Rasgon noted in his

report that, even with all the miles

logged by the most advanced proj-

ects, autonomous cars remain at

“an essentially experimental stage

in the market.”

Alphabet’s flush bank account

could get that experiment across

the finish line. But with willing

partners, the company has no need

to make that journey on its own.

—Dan Gallagher

Alphabet Unit Turns to an Electric Carpool

pany has a “massive, long-term op-

portunity” with Waymo and that

bringing in outside investors would

help the venture along its path.

It also helps to spread the risk.

Waymo is one of the most ad-

vanced of many self-driving vehi-

cle projects being undertaken by

technology companies and auto

makers. The company claimed in

January to have totaled 20 million

miles on its self-driving technol-

ogy to date. Data compiled by the

state of California and analyzed by

Bernstein Research showed

Waymo logging about 1.45 million

The company said

bringing in outside

investors would help the

venture along its path.

Fed Chairman Jerome Powell has limited firepower in cutting interest rates because they are already so low.

ERIC BARADAT/AGENCE FRANCE-PRESSE/GETTY IMAGES

Maybe the best thing that can

be said about the Federal Re-

serve’s interest-rate cut on Tues-

day is that the central bank got it

out of the way.

After all, with evidence piling

up that the new coronavirus epi-

demic may represent the most se-

rious threat the economy has

faced since the last recession, and

with economists repeatedly cut-

ting their economic forecasts, a

rate cut by the time of the Fed’s

meeting scheduled for later this

month seemed a done deal.

Investors’ apparent disappoint-

ment over a statement from

Group of Seven finance ministers

and central bankers earlier in the

day pledging to use “all appropri-

ate policy tools” to support

growth—but not offering any con-

crete steps—may have under-

scored the Fed’s need to act. The

very brief boost that the news

gave to risky assets speaks vol-

umes about what it can and can’t

accomplish.

In acting early, and in cutting

its target range by a half a per-

centage point rather than just a

quarter point, the Fed sends the

message that it is prepared to do

whatever it can to bolster the

economy against the effects of the

outbreak.

That includes further rate cuts

and, if it ends up taking overnight

rates down to zero, bond buying,

“forward guidance” promises to

not raise rates for a long time and

other kitchen-sink measures in an

attempt to stave off a recession.

But the Fed’s powers are, in

this particular case, muted.

With its target range on over-

night rates at 1% to 1.25%, it has a

limited amount of rate-cutting

firepower. Historically when the

Fed has faced a recession, it has

cut rates by around 5 percentage

points to turn things around. Low

long-term interest rates—the 10-

year Treasury now yields just

1%—makes bond buying less po-

tent as well.

Moreover, monetary policy isn’t

a good tool to fight economic

problems stemming from the cor-

onavirus epidemic.

Lower rates can’t fix supply-

chain problems faced by compa-

nies reliant on Chinese goods, for

example, or make nervous con-

sumers book vacations to Miami.

Still, the Fed’s easing move is

better than nothing and the econ-

omy will be better off with them

than without them. Investors, and

Americans at large, should be

comforted that the Fed has their

back.

By acting forcefully, the Fed

may also help bring home the

message that while it can support

the economy in the fight against

the coronavirus, it can’t lead it.

—Justin Lahart

But the yen is barely up at all

over the past month, having risen

just 0.5% against the dollar.

Though it has moved more reliably

in recent days, the yen’s increase

has been barely more pronounced

than the euro’s against the dollar,

even though the eurozone cur-

rency isn’t traditionally regarded

as a haven currency.

One reason the yen doesn’t re-

act in a predictable way anymore

is the sheer volume of overseas

buying by Japanese pension funds.

The latest data show mammoth

purchases of foreign bonds in Jan-

uary, an emerging trend that may

have changed the calculation of

how the yen behaves.

The euro itself may have bene-

fited from the unwinding of carry

trades. Investors who borrowed

cheaply in euros to invest else-

where could be closing their posi-

tions during a moment of panic

and buying euros in the process.

The equity market has perhaps

behaved more predictably. The

least creditworthy companies as

measured by their Altman Z-

score—calculated using a com-

pany’s earnings, retained earnings,

working capital and sales relative

to its assets, as well as the com-

pany’s market value relative to its

liabilities—have performed worse

than the average stock.

Those with an Altman Z-score

of more than 3, judged to be rela-

tively safe from bankruptcy, are

down by less than 1.5% year to

date. An investor who held only

those stocks might barely know a

market correction was under way.

Those with a score of less than 1.8,

judged to be distressed, are down

by around 8%.

In a selloff, the creditworthiness

of companies matters more, hid-

den pockets of leverage are re-

vealed and established relation-

ships can turn out to be broken.

Keeping an eye on how market

mechanics operate under stress

teaches investors a necessary les-

son in how to protect themselves

against future panics.

—Mike Bird

OVERHEARD

The pot stocks just can’t seem

to get out of bed.

Cronos Group announced Mon-

day that it would delay filing a re-

quired annual report with the Se-

curities and Exchange

Commission. The company said in

a news release it was unable to

complete its financial statements

for fiscal 2019, pending a review

by the board’s audit committee of

“several bulk resin purchases and

sales of products through the

wholesale channel and the appro-

priateness of the recognition of

revenue from those transactions.”

That wasn’t the only bummer

for the sector: Tilray reported

Monday that fourth-quarter reve-

nue nearly tripled in 2019 from a

year ago to $46.9 million. But

that didn’t stop the cash from

burning: Tilray posted a net loss

of $219 million for the quarter

and $321 million for all of 2019,

thanks in part to a surge in sales,

marketing and administrative ex-

penses. Tilray ended the year

with about $97 million in cash,

down from nearly $500 million at

the end of 2018.

The negative news has led in-

vestors to quickly sober up.

Shares in both companies fell

sharply Tuesday and have each

shed more than 70% over the

past year. It is hard to smoke

when you are underwater.

Virus Threatens Banks’

Trade-Finance Business

S&P500

Gold*

Japaneseyen-U.S.dollar

exchangerate

Euro-U.S.dollar

exchangerate

Performance, year to date

Sources: FactSet (indexes, futures); Tullett Prebon
(currencies)

*Continuous contract

10

–10

–5

0

5

%

JFM

RICHARD VOGEL/ASSOCIATED PRESS