“March Madness” will probably be a widely used moniker for the last month in financial markets. Despite the growing macroeconomic risk that arose from the Silicon Valley Bank and Credit Suisse fallout, volatile markets ended with positive total returns in major asset classes.
Equity markets finished the month strong, with some major changes in sector leadership. Semiconductor companies soared, and large-cap technology companies became a new “safe space” for investors. The Nasdaq rose +6.78% as the technology and communication services sectors returned over +10% each. The SPX rose +3.67% in March and the Dow Jones Industrial Average rose +2.08%. Utility and consumer staples participated in the run to quality, while financials and real estate sectors were punished in the wake of a “crisis of confidence” in banks. The financial sector fell by -9.74%, while real estate stocks fell by -2.08%.
Interest rates saw sharp moves as would be expected during a month of turmoil. Interestingly, the month started with longer-duration Treasuries topping yield levels of 4% for the first time since November of last year. Two-year notes reached 5% just as labor costs jumped. That all changed on March 7th, as the news broke on Silicon Valley bank. 2-year notes dropped over 100 basis points in yield the following week. In total, the yield curve shifted drastically lower in March. 2-year notes fell by 79 basis points to yield 4.03%, and 10-year notes fell by 45 basis points to yield 3.47%. The yield curve “inversion” eased as investors piled into short and intermediate bonds. The fear and panic were apparent in Treasury markets as news of the various banks here and in Europe broke.
Credit sectors, despite solid positive total returns for March, saw dislocations and “murky” liquidity. Trading days post banking news became very sparse and tight. Bid/ask spreads widened considerably and finance issues, especially banks, have repriced with much wider risk premium spreads. Primary issuance in the corporate bond market was halted for a good portion of the month as price discovery and focus on safety became paramount. As pressures eased, bank corporate trading remains at higher spreads, and a sub-sector of “haves and have nots” has emerged in liquid bonds.
Municipal bonds participated in the safety trade providing solid returns in March. The new issue municipal bond supply was lighter than usual for the month, which helped drive returns, along with the strong Treasury market. Municipal bonds have remained tight to Treasury ratios, despite recent volatility. As a recessionary environment persists, the “port in the storm value” in municipals may fade, as tax bases erode. Commercial real estate continues to remain weak, which may eventually hurt urban municipalities.
“Canary in the coal mine” may have been the cliché most used last month, as news from Silicon Valley Bank reverberated through the world. It drove markets while economic and inflation data took a supporting role. Even as the Fed and ECB made important decisions during the month, they were not the main catalyst for March angst. The collapse of SVB, followed by the Signature Bank Failure, and First Republic Bank liquidity issues were initial culprits. The whole banking system saw pressure as the events unfolded. Whether issues were due to systemic risk or poor management or interest rate missteps of a few players is still open for debate. Risk markets have a new level of fear for the foreseeable future.
Large banks showed up to help First Republic which provided temporary relief until Credit Suisse, after years of challenges, was in dire need of help. The Swiss National bank assisted with a 54-billion-dollar credit facility, but once again relief was short-lived. Over a weekend, Credit Suisse was forced to sell to UBS in an “arranged marriage”. News quickly spread that $17 billion in Tier 1 Bonds (AT1) contingent convertible bonds with a “wipe-out” clause, would be deemed worthless.
On March 24th Deutsche Bank had a scare, guilt by association, and its stock fell 15% overnight. It soon reversed as investors deemed it safe, and possibly “too systematically important” to fail. Mid-size US banks continued to sink but found some solid ground in the last few days of March trading. US Treasury Secretary Yellen tried to assure banks were safe, but the message was often unclear, and certainly not helpful for investors. As this all unfolded, so did major risks to future economic, and central bank policy.
Economic data was mixed in March despite continued strong employment. February’s nonfarm payroll employment release was slightly stronger than expectations as payrolls rose 311k. The unemployment rate moved slightly higher to 3.6% from 3.4%, yet to reflect layoff announcements highlighted in the news. Retail sales fell slightly but were mostly in line with expectations. Regional manufacturing reports moved sharply lower. The service sector remained strong, and housing starts and new home sales were surprisingly higher. Consumer confidence remained healthy, but expectations will surely change after a frightening month.
Inflation data remained elevated in some reports leaving the ECB and the FOMC in the uncomfortable position of combating inflation during a crisis of financial confidence. In the US, unit labor costs for Q422 unexpectedly jumped to 3.2% from 1.1%. This data came in before banks came under pressure. Average hourly earnings in the monthly employment report ticked slightly higher than in the previous report. CPI came mostly in line and PPI fell from January. The GDP price index remained the same, but the February core PCE deflator dropped slightly. While data is trending in the right direction, inflation data suggests the Fed remains quite far from its 2% inflation goal.
As mentioned, central bankers had some tough choices this month. What was once an easy call - tightening monetary policy to bring down inflation levels - became much trickier as banks faced liquidity issues, and governments were stepping in to help.
- On March 16th ECB President Christine Lagarde announced a bold move by raising rates 50 basis points, despite turmoil in the banking sector stating, “Inflation is projected to remain too high for too long”. She noted that the governing council stands ready to respond to preserve price stability and that the Euro area banking sector was resilient, with strong capital and liquidity.
- On March 22nd the FOMC announced a quarter-point rate increase, despite the volatility in markets. At the time markets were mixed as to whether they would do anything, a far cry from the 50-basis point move expected just a few short weeks ago. This was the Fed’s ninth rate hike (to 4.75-5.00%) since March 2022. Chairman Powell stated that future increases will depend largely on incoming data, which was a departure from “ongoing increases” being appropriate to fight high inflation.
- “The process of getting inflation back down to 2% has a long way to go and is likely to be bumpy”.
- “Recent developments are likely to result in tighter credit conditions for households and businesses and weigh on economic activity, hiring, and inflation. The extent of these effects is uncertain. The Committee remains highly attentive to inflation risks”.
- Bond markets, especially shorter-duration bonds rallied as the potential for a May rate hike diminished. Markets are currently pricing in rate cuts for 2023, while the committee does not expect to lower rates at any point this year.
- The next two years’ worth of projections also showed considerable disagreement among members, reflected in a wide dispersion among the FOMC Dot Plot.
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