Only when the tide goes out ...
Rapid rate increases exposing issues that were hidden when rates were low.
… do you expose a bank panic (or something like that). In just 10 days, market anxiety over reemerging inflation and a “higher for longer” Fed has given way to fears of a new global financial crisis. The immediate worry for banks is holding on to deposits. Even before Silicon Valley Bank (SVB) collapsed, an estimated $400 billion fled to money funds in the past year. Regional banks are certain to tighten lending standards further (a Fed survey showed their willingness to make loans already had declined in Q1 to recessionary levels). That could take a big toll on the economy. Banks with less than $250 billion in assets account for roughly half of U.S. commercial & industrial lending, 60% of residential real estate lending, 80% of commercial real estate lending and 45% of consumer lending. Yardeni Group is hearing a lot of “chatter about deflation” as odds of a credit crunch and recession rise. Reports Friday suggested the economy may be slowing—Conference Board leading indicators fell an 11th-straight month, Michigan consumer confidence slipped (even before SVB) and industrial production stalled. Yet for all the “hard landing” evidence (a massively inverted yield curve being the most historically accurate indicator), other data to date indicate nominal GDP could grow 8-9% (3.5% on a real basis) in Q1. The Atlanta Fed is tracking it a 3.2% pace. The global economy is doing even better. Business and consumer confidence is improving overseas and, according to Manpower, the pace of hiring accelerating.
Ultra-low rates can mask a lot of issues—and create new ones, too (see “When the tide goes out …,” below). Because SVB was so closely intertwined with tech start-ups and venture capitalists, its demise shined light on the mostly unacknowledged financial problems in the former boom areas of private equity and private lending. The rapidity of its growth, and its even speedier failure, indicate lags in monetary policy could prove longer than usual and potentially more destructive when/as they eventually hit. Stress in financials historically has long and sprawling tentacles, Renaissance Macro notes, making it difficult to ascertain their direction and depth. A lot of these strains have been hiding in plain sight. Even as higher money rates lured away deposits, the average duration of U.S. bank bond holdings was rising significantly, consistent with the now large unrealized losses on their balance sheets. Ironically, this may be one argument for the Fed hiking rates a quarter point this week instead of holding them steady. If it doesn’t do anything, that could be interpreted as a sign banking’s issues may be worse than markets think. “When it comes to bank runs, perceptions are everything,’’ Piper Sandler says. It’s not a perception that the nation’s 18th-largest bank First Republic, which specializes in private banking and servicing billionaires, was down another 33% Friday after receiving $30 billion the day before from 11 banks. At this writing, the seemingly ever-changing futures are pricing a 25 basis-point increase, with the terminal rate settling around 5% and rate cuts as early as June. Could be an interesting week.
In the moment, financial stability risk trumps inflation risk. Financial crises almost always are tied to tightening cycles. Incidentally, the last seven financial crises associated with Fed tightening lasted eight months on average. Bank of America says investors should be asking four questions: 1) To what degree was the extreme movement in Treasury rates (2-year note yields had their largest daily fall since 1982 this week) due to hawkish positioning prior to the bank turmoil? 2) Is the banking system fundamentally sound enough that problem areas can be ring-fenced by regulators (it says, “Yes”)? 3) If the Fed does cut rates to provide additional support, are those cuts likely to be permanent (it thinks the answer is, “No,’’ likening the current situation to 1987’s Black Monday shock and response)? And 4) Does the Fed need to maintain tighter financial conditions if it is going to vanquish inflation or might it claim victory at 3%? (Again, as in ’87, when Greenspan began raising rates as fears subsided, Bank of America sees rate hikes resuming.) Of all the sectors to be threatened, the last one any one wants is financials. What a mess we have made. The past week saw the eight-largest inflow into global ETFs during substantial market corrections. Humility and patience are called for.
- The consumer is nonplussed February retail sales slipped against January’s upwardly revised gain, the largest monthly increase in almost two years. So-called core sales that exclude autos, gasoline, building materials & food services rose and since September, headline sales have grown at a 4.7% annualized rate with core sales at an even larger 5.9% pace. With job and wage gains remaining strong, companies at Bank of America’s consumer & retail conference said they are seeing “a robust consumer” who is offering little to no resistance to pricing.
- Homebuyers are nonplussed—it’s spring! Starts rebounded nearly 10% in February; permits jumped an even larger 14%. This helped lift homebuilder confidence, which unexpectedly rose a third straight month in March on increases in buyer traffic and the highest present sales in six months. Mortgage purchase applications also climbed a third straight week.
- Equity investors “buying the dip” through tech Only 12 S&P 500 industries have positive returns from the index’s Feb. 2 peak, and three are in the Tech sector: communications equipment, semiconductors and technology hardware, storage & peripherals. In fact, Apple hit a year-to-date high and is back at September levels, while the relative strength in Tech helped broader market averages hold up during recent volatility.
- The only thing stronger than the consumer is the job market The Atlanta Fed’s wage tracker somewhat contradicts jobs report of moderating hourly earnings, with y/y wages accelerating to 6.6% in February from 6.2% in January and 5.5% in December. The tracker tends to better capture underlying wage trends than average hourly earnings because it controls for differences in skill levels, using microdata from the household survey to compare wages of the same person vs. 12 months earlier.
- Services inflation is sticky The services CPI rose 7.6% y/y in February, a new high for this cycle, with shelter CPI also reach a new high of 8.1%. Shelter data comes with a significant lag, however, and has yet to capture recent data showing market rents rolling over (though still running ahead of existing rents). CPI ex-shelter in fact fell to 6.9% vs. September’s 8.2% peak, though services ex shelter & medical jumped the most since last April. Elsewhere this week, headline and core PPI came in below expectations and import prices fell.
- Small business is in a terrible mood NFIB optimism rose a third straight month but is still wallowing near a decade low and at recession levels. Inflation and both the quality and cost of labor continue to headline problems confronting owners. The share of reporting job openings they could not fill rose to 47%.
Never say never At a London conference in June 2017, then-Fed Chair Yellen declared: “Would I say there will never, ever be another financial crisis? You know probably that would be going too far, but I do think we’re much safer, and I hope it will not be in our lifetimes, and I don’t believe it will be.”
When the tide goes out … Carry trades—borrowing at low rates to invest in higher-yielding assets—were turbocharged during the pandemic wave of free money. But as we saw this past week, buying longer-term bonds with short-term funds doesn’t work when the yield curve steeply inverts. The feds acted to backstop banks and depositors caught in this vise. But J.P. Morgan expects scores more of carry trades may need to unwind, from commercial real estate, auto and credit card loans to currency bets.
There’s never a good time to have a banking crisis But if the distress intensifies, it could accelerate a high-stakes debt-ceiling crisis already being pulled forward by Biden’s budget (adding $300 billion to the CBO’s deficit estimate for this year) and by Treasury’s $40 billion payment to the FDIC to cover costs associated with the past week’s bank failures.