The Fed: no secrets, no promises

Good morning. Shares in PacWest Bancorp crashed after hours, on reports it had hired advisers for a sale or capital raise. The Los Angeles-based lender, with $44bn in assets, has been subject of speculation because it’s balance sheets has some of the same faults that sunk Silicon Valley Bank. We seem to be in the midst of a mini banking crisis that neither blazes out of control, nor burns out. It just smoulders on. Email us: [email protected] and [email protected].

The Fed is done, probably

The tightening cycle has come a long way in 14 short months, and yesterday, Jay Powell took stock. He noted that the policy rate has risen 500 basis points, the Federal Reserve has shed $400bn in assets and, more recently, a string of bank failures is constricting credit. Inflation, still hot, is coming down. Yet unemployment is lower today than when tightening began. This remarkable collection of facts, at a minimum, should give us pause.

It certainly has for Powell. Though the Fed’s move, a 25bp increase alongside new language teasing a June rates pause, was widely expected, what struck us was how equivocal it all came across.

Start with the new language. In March, the Fed said it expected “some additional policy firming may be appropriate”. Yesterday, that was scrapped for looser wording saying the central bank would weigh multiple factors “in determining the extent to which additional policy firming may be appropriate”. Powell called it a “meaningful change”.

When asked if this suggests an inclination towards tightening (rather than pausing), Powell avoided the question. Many Fed watchers took it that way, however. Stephen Stanley, chief US economist at Santander, said “the new language reveals somewhat of a hiking bias”.

But bias or no, Powell reiterated the longtime message that the Fed is just waiting on the data like everyone else. He made clear he doesn’t know what’ll happen to rates, or credit, or the economy. From yesterday’s press conference, here’s his answer to whether the current stance of monetary policy is “sufficiently restrictive”:

You have 2 per cent real rates. That’s meaningfully above what many people would assess as the neutral rate. So policy is tight. And you see that in interest-sensitive activities. And you also begin to see it more and more in other activities. And if you put the credit tightening on top of that and the [quantitative tightening] that’s ongoing, I think you feel like we may not be far off. Possibly even at that level.

In other words: maybe, it’s hard to say, a lot could happen. The sentiment was repeated in this answer about whether a soft landing is still possible:

I continue to think that it’s possible that this time is really different. And the reason is there is just so much excess demand in the labour market . ..

There’s no promises in this. But it just seems to me that it is possible that we can continue to have cooling in the labour market without having the big increases in unemployment that have gone with many prior episodes. Now that would be against history. [But] the case of avoiding a recession is in my view more likely than that of having a recession. But the case of having a recession — I don’t rule that out either.

And again when asked about the scale of regional bank credit tightening:

We have been raising interest rates [which restrict credit] through the price mechanism. And when banks raise their credit standards that can also make credit tighten in a broadly similar way. It isn’t possible to make a clean translation between one and the other . . . ultimately we have to be honest and humble about our ability to make a precise assessment. It complicates the task of achieving a restrictive stance.

On credit conditions, Powell did offer a morsel of new information. Fed members had early access yesterday to its senior loan officer opinion survey (the “Sloos”, pronounced like sluice), a very important indicator. Asked what it will show, he characterised the survey as “broadly consistent” with what’s already out there in Fed surveys and bank earnings calls. Carl Riccadonna of BNP Paribas told us that even before yesterday’s meeting,

All of these things were telling us there was probably some additional tightening of lending conditions, but not a catastrophic hard-stop shift in the lending environment. We knew [it wouldn’t be] a Frankenstein Sloos that would’ve scared the Fed from tightening [yesterday]. It’s probably going to look incrementally worse when we get the data Monday.

Powell’s non-committal stance reflects a Fed trying to delicately cool an economy dragged along by consumers with the indelicate tool of monetary tightening. In the face of uncertainty, his message was: we’ll let you know when we know. No promises, no secrets.

And that’s fair as far as it goes. But our worry is that even-handed ambivalence may be the wrong approach at the top of a hiking cycle, precisely when we should most expect things to break (see: PacWest). Next month, the Fed would be wise to put the tightening campaign on ice. (Ethan Wu)

Uber and stock-based comp

Longtime readers of FT’s Alphaville blog will remember Izabella Kaminska’s long-running argument that Uber, the ride-hailing app, has an irredeemably bad business model.

The argument, in essence, is that even at world-bestriding scale, Uber has (at best) the profitability profile of a capital-intensive taxi company, not a capital-light tech company. It can’t charge a big premium over what it costs to pay the drivers and cover the wear and tear on the cars. Even where it has a monopoly or duopoly position in ride-hailing, it is not clear that its service has clear cost/speed/comfort/convenience advantages over alternatives such as bicycles, buses, subways and local car services. Profits much above Uber’s cost of capital, on this argument, seem unlikely to ever materialise.

I have always bought this argument. But now look at this:

That is Uber’s free cash flow (operating cash flow less capital expenditure) on a rolling 12-month basis. The company is now generating cash profit. Not tons of it — about 50 cents per share, leaving the stock trading at almost 80 times free cash flow. But still: profits! In the March quarter alone, the company generated $549mn in free cash flow. “Frankly, for me, companies need to make free cash flow, and so we’ve led from the front on that,” said chief financial officer Nelson Chai. Uber’s shares are up 22 per cent this month.

There is a problem, though. It is share-based compensation, which free cash flow does not capture, because it is a transaction where cash is not exchanged. But it is a real expense and, moreover, one that should be treated as a cash expense.

Here’s why. Imagine a company that issues new shares to the public, then used the cash raised to pay employees. One would not be tempted to exclude that cash expenditure from free cash flow. But in the case where the company cuts out the public, and just gives the shares to employees directly, the same economic value is being given away, just in a different form. We can’t pretend that a company that only has free cash flow before stock-based comp is really cash flow-positive. It’s just a break-even company that appears cash-profitable because it is paying employees in something other than cash.

Here is Uber’s free cash flow with stock-based comp deducted, what we might call “true free cash flow”:

Uber was, in free-cash flow terms, a barely break-even company in the past 12 months (in terms of GAAP operating and net income, it still makes losses; and the less said of the company’s preferred profits metric, “adjusted ebitda,” the better).

The idea that the company is still not particularly profitable because it has not yet arrived at scale is, of course, laughable. Bookings (rider payments to Uber) are running at a $125bn annual rate; 24mn Uber trips were taken a day last quarter.

When can we just say that this is a bad business? Maybe not quite yet. The company is still growing bookings at a 20 per cent annual clip, and a combination of price increases and cost discipline means that the profitability trend is gradually moving in the right direction — as the chart of true free cash flow shows. The question is what the company’s scaled-up equilibrium level of profitability is. I don’t know how to estimate that, but I can’t think of a reason why it would be that much different than what we are seeing right now, at a scale of 24mn trips a day. Can you?

One good read

A sharp addition to the dedollarisation debate from Adam Tooze.