Modest gains in major market indices masked sharp volatility amid the uncertainty arising from mixed messages emanating from public officials and revived banking fears. The Dow Jones Industrial Average gained 1.18%, while the Standard & Poor’s 500 added 1.39%. The Nasdaq Composite index rose 1.66% for the week. The MSCI EAFE index, which tracks developed overseas stock markets, advanced by 3.29%.
A Turbulent Week for Stocks
The stock market was unable to find sustained direction as investors weighed comments from Fed Chair Jerome Powell and Treasury Secretary Janet Yellen. Stocks initially rose as banking fears eased following a deal to acquire a troubled Swiss bank. Optimism was further fueled by Yellen, who said the government could intervene to protect depositors if more bank issues materialized. Enthusiasm faded, however, when Yellen subsequently testified that the Treasury was not working on any blanket insurance for bank deposits and by the Fed’s warning that banking turmoil could shrink lending access — the volatile week ended with sharp intraday price swings, shrugging off revived European banking concerns.
Rate Hike Cycle Ending?
Last week, the Federal Open Market Committee (FOMC) meeting was particularly noteworthy. Fed officials were placed in the difficult position of balancing the banking system's opposing risks of still-high inflation and stressors. The Committee had considered leaving rates unchanged given banking stressors but unanimously voted to raise rates by 0.25%, citing elevated inflation, resilient economic activity, and a strong labor market. The official announcement hinted that the Fed might soon be done with raising rates while also stating it was too early to ascertain the degree to which the economy could slow from the current banking strains.
This Week: Key Economic Data
Tuesday: Consumer Confidence.
Thursday: Jobless Claims. Gross Domestic Product (GDP).
Friday: Personal Income and Outlays. Consumer Sentiment.
This Week: Notable Companies Reporting Earnings
Tuesday: Micron Technology, Inc. (MU), Walgreens Boots Alliance, Inc. (WBA).
Well, like we have mentioned here all along and a few weeks ago, the Fed will raise interest rates until something breaks. Something broke and it appears to be a handful of the regional banks. Unfortunately, the worst thing that can happen to banks is a crisis of confidence. Banks borrow from you in the form of deposits and lend the money out longer term for cars and portages and other things. It works until people decide they want their money back en masse. When this happens, they can't call in the loans, they have to tap their reserves which tend to be invested in things like bonds. As you probably know, when interest rates rise, the value of bonds decline. Interest rates rose a tremendous amount last year and bond values declined quite a bit, especially for longer maturity bonds. So, in order to give depositors their money back, banks are forced to sell these bonds at a loss which impairs their reserves and creates more of a crisis of confidence.
It becomes a self fulfilling prophecy of sorts. Additionally, if banks are busy liquidating assets to meet demands for savings, they will slow down their lending which, in turn, will begin to slow the economy. It is a slow process, just like raising interest rates slowing the economy takes time. We used the analogy here before where we said the Fed has to give the poison time to take effect rather than continuing to drink more poison. They want a slightly sick economy, not a dead one. We posted this photo a few weeks ago where we said based on sentiment, inflation is truly peaking. When the cover story of a popular publication is on some topic, that topic is usually at the end of its relevance. See below.
Now, let me be the first to say I think bank deposits are safe. The Fed and U.S. Treasury do not want a 2008 redux and will do whatever it takes to keep the banking system sound. However, bank stocks will probably be highly volatile until this situation passes.
The futures market is already pricing in interest rates cuts by year end. Inflation is coming down. There's a great website called Truflation. If you're bored, go there and play around. It is quite interesting. Anyway, as you can see below their real-time measure of inflation shows a strong downward trend over the past year.
Ironically, and also because of a flight to safety, interest rates on Treasury bonds fell a tremendous amount in the past few weeks. Some of this may also be the market pricing in the aforementioned rate cuts. The chart below shows the rate on 1 year Treasury bonds. We topped out around 5.30% back on March 9th. Today, rates are at 4.45%. That is a big move in just a few weeks.
Overall, stocks have been pretty patient. Stay tuned.