The Fed won’t rely on the market

Good morning. On Tuesday, we asked what it was about Disney’s streaming business that makes its economics so much worse than Netflix’s. It seems that Disney thinks part of the reason is scale and control: Disney has offered to buy the third of Hulu that it does not already own for $8.6bn. Think it will help? Email us: robert.armstrong@ft.com and ethan.wu@ft.com.

Powell talks tighter financial conditions

An economy in rude health buys a central bank time to wait. No surprise, then, that Federal Reserve chair Jay Powell did not sound like a man in a hurry to raise rates yesterday. In his post-meeting press conference, Powell cheered inflation “progress”, rising labour supply, moderating payroll growth, and inflation expectations in a “good place”.

All the same, he said that the question on his mind remains “should we hike again?” not “should rates rise or fall from here?”. The Fed’s tightening bias remains intact. And, unhelpfully, inflation progress has slowed. Monthly core inflation was up in August and September, and ex-housing services inflation is on the rise again. Shortly before yesterday’s meeting, September data showed job openings ticking up, defying expectations. Five per cent real GDP growth is good news, but it might not be consistent with inflation at 2 per cent. It is too early for the Fed to relax. Here’s Powell: 

A few months of good data are only the beginning of what it will take to build confidence that inflation is moving down sustainably . . . 

Evidence of growth persistently above potential, or the tightness in the labour market is no longer easing, could put further progress on inflation at risk and could warrant further tightening.

That is all to say not much has changed. But yesterday’s official statement included a new reference to tighter financial conditions. This is likely a pointer to the rising 10-year Treasury yield. In theory, high long rates should suppress growth and inflation. Powell left open the possibility that higher yields could at some point act as substitutes for further rate increases.

That’s how the market read it. It took the press conference as a sign the Fed would go a bit easier. The two-year Treasury yield fell 12 basis points, stocks rallied and the dollar weakened — all loosening financial conditions.

The market may be getting a bit ahead of itself. To be confident that inflation is coming down, the Fed wants to see somewhat lower growth. In isolation, tighter financial conditions could deliver that. But remember why financial conditions have tightened recently: because of a rally in long-term real interest rates (see chart below). That is partly down expectations of higher growth. So on the margin, if growth falls, yields will follow, loosening financial conditions, and opening the way for growth to reaccelerate. We should not rely too much on higher long-term rates to do the Fed’s work for it.

Nor is the Fed relying too much on long rates. Yesterday Powell laid out two requirements for the Fed to forgo rate rises on the basis of tighter financial conditions. They are, first, that tightness should be sustained and, secondly, that a rise in yields should reflect more than just higher near-term policy rates. This is a high bar. Financial conditions have changed a lot. But the Fed’s reaction function seems mostly the same. (Ethan Wu)

Journalism as a tool for trading, or vice versa

Here’s a new business model: 

A group of veteran US financial journalists is teaming up with investors to launch a trading firm that is designed to trade on market-moving news unearthed by its own investigative reporting.

The business, founded by investor Nathaniel Brooks Horwitz and writer Sam Koppelman, would comprise two entities: a trading fund and a group of analysts and journalists producing stories based on publicly available material, according to several people familiar with the matter. 

The fund would place trades before articles were published . . . but would not trade on information that was not publicly available.

So reported the Financial Times yesterday. Congratulations, Mr Horwitz and Mr Koppelman. You have invented the hedge fund. Lots of investors hire journalists, or people who have journalistic skills, to gather information about companies — information that is not in the financial statements and indeed is not available to most investors. Some of them, most notoriously short sellers, make trades before publishing what they have found. This is an ancient practice.

(Another thing, Mr Horwitz and Mr Koppelman: what follows is not legal advice, and I’m not a lawyer.) 

The obvious question about this nascent enterprise — to be owned through a start-up called “Hunterbrook” — is whether it will explode on contact with insider trading laws. Journalists get their big stories by having sources inside companies. Only a fool would propose an investing business model, or for that matter a journalism business model, based only on a bunch of journalists combing through public documents.

But there is no obvious reason that a fund based on journalistic sourcing would be illegal.

The crucial question with insider trading, from the point of view of criminal as opposed to civil law, is whether a company insider violated a duty in providing information to an outsider. Whether the insider did that depends, in turn, on whether they expected personal benefit from it. If they didn’t, it is fine for the recipient of the information to profit from it. After all, making money from non-public corporate information is an important part of the newspaper business model, and that is fine (for the newspaper, anyway). And any information that is gathered that does not come from within a company (conversations with customers and suppliers, satellite images of empty parking lots, watching who goes in and out of headquarters) is standard investment industry stuff, and standard journalism stuff, too.

“Think about what short sellers do. Is it OK to collect information about a company? Yes. Is it OK to trade on that information before you publish it? Yes,” Daniel Richman, a professor at Columbia Law School, told me yesterday. The crucial thing, again, is that the source does not stand to benefit. “Even if the collection and exploitation of the information is something that regular members of the public might not be able to do . . . I don’t think the fact that [the recipient] is making money makes any difference.”

What if Hunterbrook trades ahead of a report that turns out to be wrong? “Short seller reports have been proved wrong. We’ve seen this movie before,” Richman says. Lawsuits may ensue, of course, as well as criminal investigations of market manipulation. The point is that the situation with Hunterbrook is not fundamentally different from business models that have long existed in finance.

So the Hunterbrook business model is not intrinsically unlawful. That does not mean it does not have legal risks. The risk of a Securities and Exchange Commission lawsuit is significant, as a lawyer with long experience of the agency explained to me. The threshold for what counts as “benefit” is very low, in a civil law context especially. A lunch? Expectation of friendship? Hopes of a cameo in a Michael Lewis book? Any of this is enough to set the SEC sniffing around. Similarly, the trigger for a market manipulation investigation on a report that moves the market is going to be very sensitive indeed.

Jacob Frenkel, a lawyer specialising in securities enforcement at Dickinson Wright, put it more bluntly: “SEC enforcement would scrutinise vigorously trading by the principals of a publication that reaches into a company, obtains non-public information, and trades on the information.”

Of course it could be that Hunterbrook doesn’t plan to “reach in” to anybody. It might instead plan to build mosaics of little bits of information available to everyone in documents and other public sources. If so, it can get in line behind a zillion other well-staffed hedge funds, and expect to earn the same mediocre returns that they do, over what is likely be a short corporate lifespan.

The most interesting question is whether owning a trading operation is a good way to finance journalism. If you found out something awful about your employer, something the world should know, would you want to share it with a company that was going to trade on that information before publishing it? Would you trust a news organisation that was funded by trading on its stories before you got to read them? These questions are important, because Hunterbrook is only an interesting idea if it is a news organisation supported by a trading operation. Trading operations supported by journalistic work are a dime a dozen.

One good read

How Bridgewater might work.

Source: Economy - ft.com