The Fed is pumping $6 trillion dollars into the US economy, but will it trickle down to the recently jobless? The latest addition to Quantitative Easing Infinity (QE8) was the announcement that the bond purchase program has extended to junk bonds and collateralized loan obligations (CLOs) on Thursday. The benefit of this purchase program ultimately extends to the largest holders of CLOs, structured products holding junk bonds.
1) Banks own ⅓ of the CLO market- Wells Fargo, JPMorgan Chase, and Citibank hold 81% of bank-owned CLOs in the US.
2) Pension Funds and Insurance companies own 20% of the CLO market.
3) Hedge Funds hold 14% of CLOs.
But this piece is about food, not cronyism.
Central banks lowering interest rates is designed to encourage greater risk taking and consumer spending. In 2008–2009, central bank policies helped money flow into stock and bond markets. But since retail and institutional investors are failing to fall for the trick, the Fed has taken it upon themselves to make risky investments.
The prudent financial move would be to raise cash, park it appropriately, unwind from risky investments and develop a strategic money management plan. Economically, this means capital is not being put to productive use as people are saving or buying a moderate amount of basic necessities. The purpose of QE is the opposite of prudence — to stimulate the economy through consumer spending, but at the moment consumers aren’t spending. Additionally, people could have all the money in the world, but they can’t buy toilet paper. Included in the list of necessities becoming scarce is many types of food.
As businesses lay off workers at levels not seen in most living generations, Maslow’s Hierarchy of Needs is in the forefront of consumer’s minds. Many are already fighting to attain the bottom tier of the pyramid: physiological needs.
In the US, reported unemployment claims have reached 17 million, which is 11% of the workforce. Many small and medium-sized businesses (SMB) focused payroll companies are reporting an average of 40% reduction in payrolls. By our models, we are already at 18% unemployment.
It’s important to remember various forms of inflation: demand-pull, cost-push, and built-in. As our last piece on inflation explained, the Fed is pumping trillions of dollars into the economy. This could actually create demand-pull inflation because there may be enough dollars to chase scarce goods.
However, the velocity of money is low, as it was in 2008, holding inflation down. In our previous article “Monetary Policy And Inflation: Is This Time Different?”, we said the risk of inflation remains low in the US but that may not be true for many other countries, and for certain types of goods, mainly food.
We expect higher food prices.
With a reduction in available supply and an increase in demand, the overall effect is higher consumer prices. Typically with supply shortages, an increase in demand for substitute goods occurs. However, for most goods, there is no perfect substitute and if there is a general shortage of food then there is no alternative.
For example, in Argentina, the cost of food increased by 54.2% in February 2020 over the same month in the previous year. In Pakistan, it was 16.2%. This is not an issue that will be isolated to anecdotal countries. This is global.
Rice exporters in Thailand are taking advantage of the situation and exporting rice at extremely high prices, in an effort to increase revenue. The Benchmark Thai white rice prices (RI-THBKN5-P1) have hit their highest level in eight years, a 12% rise from March 25 to April 1st.
“Before the lockdown, India was offering 5% broken parboiled variety at around $365 per tonne free-on-board basis. Thailand is now been offering the same grade at around $540 per tonne.”- India Today
Countries are hoarding food
Some of the largest food exporters have begun to enforce food protectionist policies:
- Ukraine has banned their buckwheat exports
- Vietnam, the world’s third-largest rice exporter, has suspended rice export contracts
- The Russian government adopted an agriculture ministry proposal to limit grain exports to 7 million tonnes
- The Eurasian Commission will restrict exports of sunseeds, buckwheat, rice, and rye
- On March 22, the Kazakhstan government announced a ban on exports of flour
- Cambodia will ban some rice and fish exports
- The customs union, which also includes Belarus, Armenia, and Kyrgyzstan, will also not be supplying soybeans and some vegetables such as onions outside of the union
- Indian rice traders have stopped signing new export contracts. India is the world’s biggest exporter
- Egypt will halt the export of legumes
- Serbia has banned the exportation of sunflower oil
- Turkey has curbed lemon exports
Of particular concern are restrictions on the wheat trade. Wheat can be seen as a political commodity because it is the main ingredient in the most basic food, bread. It has been noted that The Arab Spring of 2010 started as the direct result of grain prices spiking leading to bread riots in Tunisia and Egypt. It is important to note that Egypt’s bread prices rose 37%, that they are the world’s largest wheat importer and that more than 40% of the population live below the poverty line and suffer from some form of malnutrition.
“Wheat is the most widely grown crop in the world and provides 20% of the daily protein and of the food calories for 4.5 billion people. It is the second most important food crop in the developing world after rice.” — FAO Briefing Document
Production is largely unchanged but these key exporters have instituted trade restrictions with the intended purpose of domestic food security. These countries are the main exporters to price-sensitive countries, which rely heavily on these exports:
Kazakhstan’s protectionist policies are particularly concerning as it is the primary supplier to the region and therefore these importers will face a serious food shortage of wheat (grain).
These protectionist policies ring the alarm for global food security.
Disrupted Supply Chains
I have followed The Baltic Dry Index (BDI) since I was an emerging market bond analyst. This leading indicator can be used to characterize the state of economic activity. Rather than a retrospective indicator such as GDP, the BDI provides real-time monitoring of economic processes (more specifically, demand for commodities and raw materials). The BDI has been dropping for the past 6 months. The shipping market was already on a downward trend before COVID-19, and there is no indication near-term capitulation.
The port of Los Angeles reported a volume drop of 30.9% in March compared to a year ago.
Airfreight and trucker shortages, limited port hours leading to port backups, grounded planes, and spoiled perishable food all lead to less availability. We are approaching prime harvest, but due to border closings, we have massive labor shortages and farmers are unable to hire their usual migrant workers.
Corn farmers are especially vulnerable because a combination of low oil prices has cut the demand for ethanol, of which corn is the primary product. Farming operations are struggling, forcing trade groups to lobby the Trump administration for emergency financial aid.
Due to quarantine bans, consumer demand for beef, poultry and fish have dropped as restaurants shuttered. Additionally, as more people file for unemployment and become financially strained, people opt to buy cheaper nonperishable goods. A highly efficient supply chain is necessary for nonperishable goods, causing farmers, fishers, ranchers, bakers to experience lower demand for their products from grocers and restaurants.
“The COVID-19 crisis also has the potential to spark a food security crisis in Africa, with agricultural production potentially contracting between 2.6% in an optimistic scenario and up to 7% if there are trade blockages. Food imports would decline substantially (as much as 25% or as little as 13%) due to a combination of higher transaction costs and reduced domestic demand.” World Bank press release on April 9th.
Many countries import much of their food, focusing our attention on the developing world, where the largest percentage of consumer spending is on food.
Ample food is still produced in the world, so the issue is availability rather than supply.
As the pandemic and economic downturn continue, supply lines will continue to be disrupted, food inflation will continue to rise, national food protectionist policies will be further enforced, and this will lead to global food shortages. Countries already most affected are Afghanistan, Burkina Faso, Burundi.
“The risk of major interruptions to food supplies over the coming months is growing, especially for low-income net-food-importing countries, many of which are in sub-Saharan Africa,” — The Food and Land Coalition (a group comprised of Unilever, Nestlé and PepsiCo, along with farmers’ organizations, the UN Foundation, academics, and civil society groups).
Economically, global food shortages will devastate emerging markets who depend on food imports, such as Nigeria and rice, as well as countries that depend on exporting their food. This loss of income and national GDP growth provides a further catalyst for malnutrition and food scarcity, economic turmoil, and currency inflation.
“According to the Institute of International Finance, foreign investors have withdrawn $95bn from stocks and bonds since they woke up to the crisis on January 21. That is four times the outflows in the same period after the start of the 2008 global financial crisis.”
Most developing countries rely on remittances, which are not able to arrive. Capital is pouring out. The tourism industry has collapsed. Emerging-market assets are dumping. The shutdown of global economic activity will make it exceedingly difficult for fragile economies who have already been financially stretched to effectively respond to the pandemic. How do you balance economic collapse and a public health response?
In many parts of the world, starvation and COVID-19 may be equally as deadly.
As we see more trade border closings and xenophobia, countries with the highest food costs, net food importers, and Consumer Price Index (CPI) rates heavily weighted to nutrition will have an outsized inflation increase and GDP decrease globally. Of those countries, many such Vietnam and the Philippines that have seen high GDP growth over the last 10 years could be hit the hardest in the short run. Considering that JPMorgan has estimated that US GDP will fall by 40% at an annual rate, it could take many years for the hardest-hit economies to recover.
Steven McClurg — CIO
Leah Wald — CEO
Valkyrie is a discretionary global macro investment management firm. By analyzing fundamental macroeconomic, geopolitical, and social factors we are able to listen to the markets and effectively manage risk and generate alpha.
Valkyrie believes that shifts in government economic policies, political climates, currency exchange rates, international trade, international relations, and interest rates impact all financial markets. Utilizing this expertise of the global economy and financial markets, ExI has constructed unique portfolios with a dynamic macro edge that includes exposure to emerging asset classes.
Together, Steven and Leah utilize macroeconomic strategy to structure and manage portfolios.
About Steven McClurg (CIO):
Steven McClurg is the Chief Investment Officer at Valkyrie. He was a managing director at Galaxy Digital, through the acquisition of his previous company, Theseus Capital, where he was a founding partner and CEO/CIO. Steven started his asset management career at Guggenheim Partners, a leading global investment and advisory financial services firm, where he was managing director and portfolio manager, including oversight of Emerging Markets and Sovereign Credit.
About Leah Wald:
Leah Wald is the CEO at Valkyrie. She was a Partner at Lucid Investment Strategies, an asset management firm specialized in investing in macroeconomic trends. Prior to joining Lucid, Leah was at Vital Financial analyzing investment strategies for Japan, Asia, Middle East energy, and global macro strategy. Leah started her career working at the World Bank Group reporting directly to the former Vice President of the Africa Region.