What's Next? RISE Market Update

What’s Next?

Zach Harrington

All eyes are on a different kind of March Madness here in 2023 as a soft landing appears to be off the table for the US economy and many investors are trying to figure out: What’s next?

The first quarter of 2023 has been incredibly volatile – investors looking for a reprieve from 2022 volatility were teased in January and then reminded very quickly throughout February and March about our current macro-economic environment and the uncertainty surrounding it. January kicked off a hot month for growth stocks and longer duration bonds, as prospects of a softening federal reserve and softer landing of the economy led to a NASDAQ up 10.68%¹ in January and the 10-year yield dropping close to .50% ². Then came February inflation numbers, jobs data, and Fed minutes that sent investors scrambling for direction – combined with a Fed seemingly committed at all costs to higher rates for longer and more hikes – sent markets significantly lower. Now in mid-March, equities have become exhausted and have turned flat to negative year-to-date.

Overall, sentiment amongst institutional managers and economists was that the Federal Reserve would continue raising rates until “something” broke. Enter to the conversation: Silicon Valley Bank (SVB), the second largest bank failure in US history. A bank that specialized in private equity/Venture Capital lending, went from Wall Street Darling to bankrupt in just a few months. The news around SVB’s collapse has been plentiful and everyone from institutional investors to regular banking customers have been rattled about what this could mean for the larger banking system. 

In a turn of events, Sunday March 12^th, the Fed/FDIC/Treasury stepped in and guaranteed all depositors of SVB, including those above FDIC limits³, as a good faith measure to give confidence in the US banking system and prevent widespread runs on banks.

I think there is more to the bail out of depositors at SVB, with it being just as much related to the ongoing battle between the Fed and inflation as it does with rescuing depositors. The Federal Reserve, who claims to be “data dependent,” wants to raise rates again at their March Fed meeting on 3/22 and 3/23.  If they allowed those depositors to lose assets, while also raising rates in the face of the second largest bank failure in US history, it would diminish any remaining credibility they have. 

The ball is in Jerome Powell’s court next week and if we look at some key data points it seems like the Fed needs to pause the rate hiking and acknowledge the lagging effects of their yearlong rate hike spree showing up across the economy.

 

  The market seems to be pricing in a Fed pause or 25bps hike next week. When you look at Fed Fund Futures associated with the March FOMC meeting there is 60% probability of 0 rate hike and 40% probability of 25bps⁴:

 

 

Just last week there was 75% probability that the Fed would hike 50bps, just yesterday (3/14/23) the probability of a 25bps hike was 80% and today the market points to no hike on the Fed Fund rate. What has changed?

•         Insolvency of SVB and FDIC rescue of depositors.

•         Concerns of widespread runs on our banking system.

•     Credit Suisse losing Saudi Investment and sending shockwaves throughout the European banking system.

•       Consumer Price index (CPI) continuing to turn over with rents and housing remaining a sticky part of the Fed’s preferred measure of inflation.

•         Sentiment shifting around regional bank behavior and pending credit tightening.

While there are a lot of moving parts, let’s look at two of those pieces specifically: CPI trend and regional bank behavior.

February CPI⁵ data was in line with expectations, pulled back to fall of 2021 levels and two of the biggest drivers of inflation (food and energy) were negative to flat year-over-year. This is a sign that tighter monetary policy is certainly slowing down the rate of inflation but is not disinflationary. 

 

Regional banks are incredible stewards for small businesses as they seek funding to grow and participate in the US Economy. These regional banks play a key role in facilitating accessible credit to these businesses and according to Torsten Slok – Chief Economist at Apollo – “Small banks account for 30% of all loans in the US economy, and regional and community banks are likely to now spend several quarters repairing their balance sheets. This likely means much tighter lending standards for firms and households even if the Fed would start cutting rates later this year.” Slok added commentary to the chart below he provided on his blog “The Daily Spark”⁶:

Let’s digest what Slok is saying here – tighter credit standards will mean less available loan volume for businesses and consumers as the year progresses. This phenomenon will bring down personal and commercial loan volumes, lowering money available in the economy and lowering economic activity even in the face of lower rates.  This will more than likely kick off a recessionary environment and a disinflationary environment. So regardless of the Fed action, the response by these small to mid-size banks to shore up their balance sheets in the aftermath of the SVB insolvency will lead to tighter conditions.

What should you be doing in your own situation?

·        Now is a time to own quality in your portfolio and stay the course. 

o   When economies exit recessionary times and enter early business cycle activity, returns are fast and robust. 

o   Owning value stocks and high credit quality fixed-income should help buffer volatility over the next 3-6months.

·        It is crucial to evaluate your current FDIC insurance levels and any exposure you may have above $250,000 per account.

·        Be prepared for stricter lending standards when it comes to mortgages, car loans, and other types of loan instruments.