Two weeks ago, the collapse of Silicon Valley Bank (SVB Financial) triggered the current financial crisis and these aftershocks continue. The severity of the shock is far more evident in the credit/rates markets than it is in equities.
- S&P 500 is up +2.3% since 3/10 (close) led by Technology/FAANG and even Bitcoin (to an extent)
- The aftershocks continue. Regional banks are large players in commercial real estate (>2X larger than large banks) and credit markets are beginning to price in heightened risks in CMBS and other markets.
- In credit/rates, there remains significant carnage as the panic around deposits triggered an explosion of rates volatility and collapse of liquidity that amounted to a “black swan” event in credit. There are obvious signs such as the collapse of Credit Suisse (CS UBS -0.10% ) and the continued distress in some regional banks including First Republic (FRC), PacWest (PACW) both down >60% since then.
- In speaking with our credit-focused clients, trading in credit remains highly choppy and volatile, evidenced by the continued high levels of volatility measures like the ICE MOVE Index, which at 151 is well above 100 seen around “normal” times. A 150 is roughly equivalent to a 30-level for VIX. So this gives one an idea of how risk positions would be limited given the volatility. And in the meantime, the higher cost of funding for all financial institutions (everything impacted), means liquidity in credit/rates are impacted. So one cannot say credit/rates are giving a “risk-on” signal.
- We view the Fed’s decision of +25bp as overall dovish as Powell, in the press conference, made clear the Fed is now closely monitoring the knock-on effects from the current banking crisis. Powell use the word “tight” in regards to policy/lending 23 times compared to 8 times in Feb. And labor market tightness garnered a mere 2 references.
- To us, this means the Fed is focused on the impact of the banking crisis and its associated ripple effects on the economy via credit contraction and lower consumer confidence. In fact, the Fed even noted this crisis is equivalent to a tightening of monetary policy. As we noted earlier this week, we think the Fed trajectory has now forked lower. We think at most there might be one more hike before YE, but even that could be doubtful as we think inflation similarly legs lower.
- To track the status of this crisis, we have previously 4 things to watch closely:
(i) MOVE Index (bond volatility) below 150 (151 now)
(ii) First Republic (FRC) comes to a resolution
(iii) Regional bank deposits stabilize (Tables 9 and 10 of Fed’s H8)
(iv) VIX Index falls below 20
extra credit: bank funding stabilizes at Fed (H4)
- So far, none of the above 4 is back within ranges deemed “less crisis” but progress has been made. This is the reason equities are whipsawing over the past few sessions. And this mirrors the same choppy trading seen in credit/rates.
- The latest Federal Reserve Balance sheet (H4 link) shows. Calmer than week prior (+$94b this week vs +$300b last week)
– borrowings “discount window” down -$42b (from $152b to $110b)
– new BTFP facility up by +$42b (from $12b to $54b)
– Other credit up +$37b <–FDIC related
- 5 reasons Tech/stocks holding up better than credit. You might wonder, why has the S&P 500 actually risen +2.3% when a credit crisis is underway? We don’t think this is entirely irrational. We can think of 5 reasons:
(i) Fed pivot underway, meaning no more hikes favoring Technology/FAANG
(ii) inflation expectations dropping, lowering nominal rates = higher P/E but not recession risk
(iii) for an investor, owning a FAANG stock is “safer” to keeping money at brokerage/bank
(iv) bank crisis is not systemic, even if investors are fearful such is the case
(v) there is nobody left to “sell” evidenced by fact money market cash balances exploded higher with $1.86T of retail cash on sidelines.
Bottom line: after-shocks continue but stocks relative strength is important
Ultimately, we think the relative strength of equities is important. Take a look at the performance of assets since 3/10 (collapse of SIVB). 4 assets surged:
- Bitcoin +41%
- FAANG +11%
- Gold +5% <– impressive
- Tech x-FANG +5%
There it is. This is a flight to “safe” assets and leading this is Bitcoin and FAANG.
Regional banks are playing a crucial role in commercial real estate. As the chart from Goldman Sachs shows, small and medium-sized banks accounted for nearly 80% of total commercial real estate lending. Compared to other types of loans, smaller banks appears to have more exposure on commercial real estate. Credit markets are beginning to price in elevated risk in CMBS.
FOMC: Powell cited “tight” in relation to credit/policy 23 times
Our data science team, led by “tireless Ken,” identified 23 instances Powell used “tight” during the 3/22 press conference.
- this is 23X in March compared to 8X in Feb
- “tight” regarding labor was only cited twice
- as shown below, Fed is now focused on the second order and continued effects of the credit crisis
He even made specific reference to this:
- financial conditions tightened “probably more than the traditional indices say”
- we completely agree
- this surge in MOVE index is a massive tightening of financial conditions
CASH: $117 billion into money markets this past week
Take a look at the surge into money market funds.
- +$117 billion in the past week
- granted, some of this is deposits pulled from banks and moved to money markets
- but the retail balances are staggering and now $1.86 trillion
Why would FOMC members raise dot plots? Out of touch?
Paradoxically, FOMC members actually raised the dot plots for 2023 vs Dec forecasts (aka SEP, or Summary Economic Projections):
- 1 member sees rates 5.75% to 6.00% now vs zero in Dec
- 3 now see 5.50% to 5.75% vs 2 in Dec
- Raising dot plots while a bank crisis is unfolding
- Doesn’t this seem somewhat out of touch?
ECONOMIC CALENDAR: U Mich next week most important in our view
There are some key inflation data points next week:
- most notably PCE deflation for Feb (its late)
- U Mich 1-yr inflation March final (more important)
CALENDAR: Key incoming data starting March 19
The big event this week is FOMC. That is the only real macro data point:
3/7 10 am ET Powell testifies SenateHawkish3/8 10am ET Powell testifies HouseNeutral3/8 10am ET JOLTS Job Openings (Jan)Semi-strong3/8 2pm ET Fed releases Beige BookSoft3/10 8:30am ET Feb employment reportSoft3/13 Feb NY Fed survey inflation exp.Soft3/14 6am ET NFIB Feb small biz surveySoft
3/14 8:30am ET CPI FebTame3/15 8:30am ET PPI FebTame3/17 10am ET U. Mich. March prelim 1-yr inflationBIG DROP3/22 2pm ET March FOMC rate decisionDOVISH- 3/31 8:30am ET Core PCE deflator Feb
- 3/31 10am ET U Mich. March final 1-yr inflation
Watch these 4 signs to see first signs the crisis ebbing
As we have mentioned recently, we get the sense that investors are being patient. They want to see how markets react to these multiple actions and how the Fed responds to the market turmoil. This means stocks are buffetted by these aftershocks.
The natural question is what are the signs this crisis might be ebbing?
– MOVE Index (bond volatility) below 150 (151 now) and hopefully settles below 125
– VIX Index falls below 20
– First Republic (FRC) comes to a resolution
– Regional bank deposits stabilize (Tables 9 and 10 of Fed’s H8).
First Republic still remains unresolved as evidenced by the volatility in the equity and bond prices. The best case scenario is for FRC to remain independent.
- the actions by the rating agencies last week and Sunday to downgrade seem so backwards looking and essentially impeded FRC’s ability to fund cost effectively
- a “white knight” might still emerge
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