Equity markets delivered an impressive gain in a disruptive week that was an eerie reminder of bank selloffs during the global financial crisis. Investor worries have rapidly shifted from the Fed and inflation to banks and interest rates. Given the pressure on the banking industry, the resilience of the equity market has been encouraging. Regional bank stocks have been punished, with the KBW Bank Index down 28% this month. High-duration equities, such as the FAANG complex, have benefitted from lower rates, with the Russell 1000 Growth Index and the NASDAQ positive this month. Volatility was elevated, with the VIX breaking above 30 before settling near 25, while the MOVE Index (a measure of bond market volatility) touched levels only seen during the financial crisis in the 35-year history of the index. Commercial paper spreads and the TED spread (the rate banks lend to each other) are at the widest level since the outbreak of the pandemic.
Investor sentiment has taken a beating on the growing uncertainty in the market, with the AAII Sentiment Survey showing the gap between bulls and bears dropping to -29%, the lowest level since December, with bulls down to 19%. A JPMorgan survey showed a record low of just 29% of investors plan to increase equity exposure, while Morgan Stanley’s Risk Demand Index fell to -3.6%, the lowest level since 2021. Money market funds saw the strongest level of inflows since the early stages of the pandemic, adding $121 billion in the latest week to bring the total to $5 trillion.
Despite the bond market showing signs of stress, a growing chorus drawing comparisons to the 2008 financial crisis, and the pain experienced by a small number of banks, we are optimistic that the disaster scenarios people fear can be taken off the table given the resilience of the equity markets and the improved capital position of the banking industry since the GFC.
The contrast between the bond and equity markets is on display leading up to Wednesday’s FOMC meeting. While the bond market is increasingly betting on a pause in rate hikes, the equity market is expecting a 25-basis point hike. If the Fed pauses its tightening, we expect panicked reactions by equity and bond investors.
Dominoes continue to fall in the banking industry, with Credit Suisse forced into a merger with UBS by regulators, with the value in Credit Suisse equity down nearly 90% over the past year and a 99% drop since before the financial crisis. “The accelerating loss of confidence and the escalation over the last few days have made it clear that Credit Suisse can no longer exist in its current form,” Credit Suisse Chairman Lehmann said. In the U.S., First Republic is in talks to sell part or all of the company, while New York Community Bancorp bought all the deposits and some loans from the failed Signature Bank. A coalition of midsized banks has called for the FDIC to back all uninsured deposits above $250k for the next two years. Large, money center banks, have been taking shares in deposits, as they are seen as a safe haven and/or too-big-to-fail.
The disruption in the banking industry has eerie echoes from the early days of the global financial crisis, further complicating the job of the FOMC during their meeting this week. JPMorgan estimates that the headwinds from credit disruption could erase 0.5-1.0% of GDP in coming quarters. On Sunday, the world’s largest central banks (Fed, ECB, BOJ, BOE, BOC, SNB) jointly announced an effort to ease liquidity pressures by strengthening U.S. dollar swap line arrangements. Following Chair Powell’s hawkish comments to Congress two weeks ago, the Fed Futures curve embedded a path that had the Fed Funds rate at 5.44% in January 2024. As of Monday, the estimated rate had fallen to 3.59%, suggesting a net seven 0.25% moves have been taken out. The curve embeds a 50-50 chance of a 0.25% or no hike on Wednesday. Powell’s comments in the press conference and the update to the Statement of Economic Projections (“dot plot”) will be closely watched.
The Fed’s concern over the banking disruption needs to be balanced against stubbornly high inflation. Consumer price inflation rose 0.4% sequentially in February and 6.0% from a year ago, in line with expectations and down from 6.4% in January. Excluding food and energy, core CPI rose 5.5% from a year ago, but was modestly higher sequentially 0.5%. Shelter costs, the largest component of CPI, continue to rise, up 8.1% from a year ago. The “super core” measure of CPI, which excludes food, energy, and shelter, was up 3.7% from a year ago. The index of leading indicators fell 0.3% in February, worse than estimated, while consumer sentiment fell for the first time since September. However, not all data is bad, with the Citigroup Economic Surprise Index at +58m the highest reading in nearly a year, and the Atlanta Fed’s GDPNow model forecasts 3.2% growth in the first quarter.
What to Watch
The FOMC meeting and Chair Powell’s subsequent press conference on Wednesday will be the primary focus of investors this week. Economic data is fairly light, including existing home sales on Tuesday, new home sales on Thursday, and durable goods and PMI data on Friday.
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