Wentz Weekly Insights
Fed Suggests Credit Tightening From Banking Issues Means Less Rate Hikes

After all the back and forth movements last week, stocks managed to finish over 1% higher for the week. The yield curve, the different between rates on bonds that mature longer-term compared to bonds that matures sooner, remains inverted, but U.S. government bond (treasury bond) yields are significantly lower than where they were prior to the banking issues. The 2-year Treasury note’s yield peaked this year at 5.10% on March 8, the highest since 2007, and has since fallen to 3.78% as of Friday, while the 10-year Treasury yield was 4.01% on the 8th and finished at 3.38% on Friday. Over that period the 10-year bond has rallied 5.1% as investor flows move to safe haven assets as the prospects of a recession increase.
The most anticipated event of the week was the Federal Open Market Committee’s (FOMC) second meeting of the year, in which it announced a 25 basis point increase to the federal funds rate. But causing bigger reaction for stocks was commentary from Janet Yellen on the banking sector and the chances all bank deposits become insured. Yellen said on Wednesday, at the same time Fed Chairman Jerome Powell’s press conference was happening, that she was not considering blanket insurance for U.S. banking deposits without approval from Congress. Stocks moved lower for the remainder of Wednesday’s session after those comments, finishing down over 1.5%. Stocks reversed course on Thursday after Yellen adjusted her comments in a hearing in front of Congress, saying the Treasury is prepared to take additional action if warranted.
Powell’s press conference following the meeting provided us with some context on how the Fed sees the banking developments affecting the economy and monetary policy. Fed officials expect the recent developments to tighten financial and credit conditions which is expected to work similarly to Fed policy, with Powell suggesting the tightening would be equivalent to one or perhaps several rate increases. As a result, the consensus at the Fed no longer sees several more rate increases as necessary, and the Fed used the policy statement as a chance to set the path for a pause in the rate hike cycle.
In addition to the policy adjustment, the FOMC released its updated summary of economic projects (SEP) to show officials projections on things such as growth, inflation, employment, and policy rates. While the projected peak policy rate was unchanged at 5.1% compared to the December projections (versus the current 4.8% policy rate), Powell said a couple weeks ago (before the bank failures) it looked like “we’d need to raise rates over the course of the year more than what we thought in December.”
What was interesting is economic growth projections were revised lower to 0.4% growth for 2023 and 2024 was revised lower to 1.2%. Growth for the first quarter this year is trending around 2%-3% (annualized). To get to a 0.4% growth rate for the year, that would mean the second half of the year would need to see decline in activity, meaning the Fed is basically telling us it forecasts a contraction in activity, or a recession. Despite this, it expects rates in 2024 to remain higher than what it expected in December, with just three rate cuts in 2024 to 4.3%.
This, again, is leading to a large divergence between what the Fed is telling us and what the markets are expecting. Markets began to price in a 5.6% peak rate several weeks ago due to strong economic data in January and February, but after the banking crisis, now see the current rate as peak. In addition, markets are expecting 150 basis points worth of cuts by the end of the year to around 3.6%, well below the Fed’s 5.1% projections. It sees further rate cuts in 2024, while the Fed projects 4.3%.
Speaking on inflation, Powell said the story is pretty much the same as its previous meeting (February 1), and it is seeing less progress in bringing down inflation in the non-housing service sector. Powell said this may take softening of consumer demand and labor market conditions.
There are three ways financial conditions tighten and we are now experiencing all three of them. One is quantitative tightening, or the reduction of the Fed’s balance sheet which reduces reserves and removes money from the financial system. The Fed’s assets have declined from a peak of $8.67 trillion at the beginning of 2022, to $8.34 trillion before the banking crisis. However, assets have increased back to $8.73 trillion as of last week as banks borrow from the Fed for liquidity. The second method is higher rates. Interest rates have risen from 0% the beginning of last year to 4.85% currently, impacting borrowing costs. The final way is through people taking deposits out of the banking system. As consumers have realized they can earn a higher rate on cash than the near 0% banks still offer, for example money market rates which are now near 5% as of Friday (if you have cash on the sidelines and are looking for a higher rate, please reach out to us for options), outflows of deposits have spiked. Meanwhile, over the first 20 days of March, money market assets have grown by $193 billion to a record $5.4 trillion.
All three of these have caused tighter financial conditions, have led to the banking crisis, and will eventually lead to an economic contraction. The recent developments in banking sector will lead to tighter credit conditions and impact borrowing, further weighing on economic activity. While the recent credit tightening may result in less rate increases, it is expected to lead to lower growth. Markets are acknowledging this and is why bond yields have moved lower and growth stocks have outperformed value in recent weeks. However, in recessionary environments, value and income producing investments will hold up better, which is why we continue to favor these investments.
Week in Review:
Stocks were mixed on Monday, but mostly higher over additional efforts to support the banking sector. Over the weekend, helped brokered by the Swiss government and Swiss National Bank, UBS agreed to acquire struggling Credit Suisse. Tech stocks involved with artificial intelligence slid on the day after the CEO of ChatGPT warned of potential risks of AI technology. Meanwhile, banking stocks recovered somewhat after the weekend news that UBS would acquire Credit Suisse and calls by a group of midsized banks to have all deposits insured. Value outperformed growth for the day and the S&P 500 gained 0.89%.
Banking stocks moved higher again on Tuesday over improving sentiment after reports that the U.S. Treasury is looking at options and whether it has authority to temporarily insure all bank deposits if banking issues worsen, and Treasury Secretary Yellen saying the Treasury is prepared to intervene again if smaller banks suffer deposit runs that pose a risk of contagion. It was a pretty quiet day elsewhere as markets look ahead to the Fed meeting. Existing home sales matched housing starts in surprising to the upside and ending a 11 month streak of declining home sales. Treasuries were under pressure as yields moved higher, the 2-year yield seeing its largest move up since 2009 (rising 25 bps to 4.18%), with stocks higher as well as the S&P 500 gained 1.30%.
Stocks were in waiting mode for the afternoon’s Fed decision and opened Wednesday relatively unchanged. As was widely expected, the FOMC voted to raise rates 25 basis points, with no changes on its rate projections for 2023, at 5.1%, suggesting one more increase, while suggesting the recent banking issues may lead to credit tightening and may mean less rate hikes than previously expected, while paving the way for a pause in rate hikes soon. Markets moved higher with yields lower immediately, but stocks moved lower halfway through Powell’s press conference which coincided with a statement by Yellen that the Treasury is not working on a unilateral extension of deposit insurance. The 2-year Treasury yield fell 24 basis points to 3.93% while stocks were lower across the board with the S&P 500 falling 1.65%.
Stocks opened higher after digesting the Fed meeting and Powell’s comments, realizing we are closer to an end to the rate hike cycle. Jobless claims were unchanged in the latest week, remaining at historically low levels, while sales of new homes rose to the fastest pace since April last year. Early morning strength faded in afternoon trading, with stocks going negative briefly before comments from Yellen that the Treasury would be prepared to take action if warranted provided some support. By the end of the day yields on Treasuries fell slightly while stocks rose 0.30%.
Banks were back in the spotlight again early Friday after Deutsche Bank credit default swaps (basically the insurance cost against default) spiked, driving selling across the globe, which caused a lower open in U.S. trading. However, stocks were able to reverse course with interest rate sensitive sectors like real estate, utilities, and consumer staples outperforming as stocks closed 0.56% higher.
Growth stocks continued to outperform value as the prospects and expectation for rate cuts this year increased, which contributed to the decline in Treasury yields, oil moved slightly higher over reports the U.S. could be refilling the Strategic Petroleum Reserve soon, while the dollar declined slightly. Treasury prices moved higher as yields were lower for the week, after trading in a wide range with the 2-year yield ending at 3.78% and 10-year at 3.38%, oil rose 3.5%, the dollar index fell 0.6%, and the major U.S. stock indices finished as follows: NASDAQ +1.66%, S&P 500 +1.39%, Dow +1.18%, Russell 2000 +0.52%.

Recent Economic Data

  • Similar to the housing starts report several days earlier, existing home sales surprised to the upside in February with the sales pace of existing homes rising by 14.5% in February compared to January, the first monthly increase in 12 months. The seasonally adjusted annualized pace of existing home sales was 4.580 million, while up in the month, is still down 22.6% from February 2022 (not as bad as the 12-month change of -37% in January). This is based on transactions closing, so the numbers reflect lower mortgage rates that we saw late 2022 and early 2023, before they rose again in February. The median price for an existing home fell slightly from February 2022, down 0.2% to $363,000, ending the longest streak on record – 131 consecutive months (11 years) of year-over-year increases. We do not expect prices to fall too much because inventories are still at very low levels. The level of existing homes on the market was unchanged from January at 980,000 units, and up 15% from a year ago. The NAR Chief Economist said “inventories are still at historic lows” and “multiple offers are returning on a good number of properties.
  • The trend in new home sales was similar to existing home sales and housing starts, with sales of new single-family homes rising 1.1% from January to a seasonally adjusted annualized pace of 640,000, but 19% below February 2022 levels, and in line with expectations. This compares to the low of 543,000 back in July, but the best sales pace since April last year. New home sales are based on signed contracts of newly built homes, not closings, so it represents February signings after the small spike in mortgage rates after January’s declines. The median sales price was $438,200, up 2.7% in the month from a two year low in January, and up 2.5% from a year earlier. Inventory of new homes worsened, with just 427,000 units available, the lowest since last February, equaling 7.2 months supply at the current sales pace, down from 8.0 months in January.
  • The weekly Freddie Mac mortgage survey shows the average prime 30-year mortgage rate fell to 6.42% last week for the first drop in six weeks, compared to 6.60% the week prior. Mortgage rates have not fallen as much as the 10-year treasury, which are typically pretty well correlated, because of the stress in the banking system.
  • The number of unemployment claims filed the week ended March 18 was 191,000, relatively unchanged from the week prior, with the four-week average at 196,250, also relatively unchanged. The number of continuing claims was 1.694 million, up 14k from the prior week, with the four-week average at 1.684 million.

Company News

  • Trucking company Knight-Swift Transportation said it has agreed to acquire U.S. Xpress in a $808 million deal, or $6.15 per share, which is a massive premium to the $1.50 shares of U.S. Xpress were trading at prior to the announcement.
  • Ford said it will restructure its business and its reporting segments; Ford Blue (its legacy combustible vehicles), Ford Model e (its EVs), and Ford Pro (its commercial products/services). It said it lost $3 billion in electric vehicle business over the past two years, and it expects to lose a similar amount in 2023 (for comparison, its combustion unit (non-EV) generated $10 billion in profits). However, it expects the EV unit to be profitable by 2026. Ford reiterated its 2023 forecast.
  • Homebuilder KB Homes beat most metrics against analysts expectations in its earnings release and said it saw a notable increase in sales through the quarter and is not seeing tightening lending standards yet.
  • Shares of Block, formerly known as Square, were down significantly last week after Hindenburg Research, an activist focused on short selling (betting stocks will go down), published a report accusing the company of overstating its user counts and understating customer acquisition costs, after a two-year investigation into the company.
  • Due to concerns about TikTok’s data privacy standards and its ties to the Chinese government, the U.S. has been pushing for an outright ban of the social media app. In 2020, President Trump attempted to ban the app, which was blocked by the courts, now President Biden is pushing for a ban, which is seeing support among Congress. Last week, TikTok CEO Shou Zi Chew appeared before Congress to testify in the company’s attempt to save the app in the U.S. and revive trust from U.S. officials. TikTok is used by over 150 million people in the U.S. and is owned by Beijing based ByteDance.
  • This morning, First Citizens BancShares agreed to purchase Silicon Valley Bridge Bank (the failed Silicon Valley Bank’s deposits and loans) from the Federal Deposit Insurance Corporation (FDIC), while the $90 billion in securities and other assets will remain in receivership at the FDIC for disposition.

Other News

  • The weekly report on the Fed’s balance sheet has been watched more closely over the past two weeks to get an idea of how much banks are borrowing from the Fed and looked at as a sign of any additional stress in banking system. Its latest report from last week showed the balance sheet rose $94 billion last week (lower than the $300 billion increase from the week prior), with a $42 billion increase in lending to banks through the new lending facility to $54 billion, and loans to bridge banks (created after the failure of the two banks) rose $37 billion to $180 billion.
  • Many of the market’s moves last week were driven by messages from the Treasury and FDIC about FDIC insurance on deposits, where we saw mixed messages. During Powell’s Wednesday press conference, Janet Yellen said she was not considering blanket insurance coverage for all U.S. banking deposits without Congressional approval. This sent stocks lower on Wednesday. However, in Yellen’s testimony to Congress on Thursday, she said the Treasury is prepared to take additional actions if warranted, sending stocks higher.
  • There were multiple other central bank meetings across the world last week. The Swiss National Bank raised its benchmark rates 50 basis points to 1.50%, in line with expectations, despite recent Swiss banking turmoil, particularly Credit Suisse. The Bank of England raised rates 25 bps, which was somewhat expected, with a 7-2 vote. The Norges Bank raised rates 25 bps to 3.00%. Central banks of Hong Kong, Philippines, and Taiwan all also raised their respective policy rates.
  • St. Louis Federal Reserve President James Bullard said in an interview Friday, the first policymaker to speak since the FOMC meeting, that the Fed would likely need to raise rates further than he previously expected due to the stronger economy and inflation than previously thought. His peak rate expectation increased to 5.50% to 5.75%, indicating three more rate increases, up from the consensus among Fed officials of 5.00% to 5.25% as indicated in the latest Fed projections released after the FOMC meeting. Bullard acknowledged the banking issues and a downside scenario, calling the Silicon Valley Bank failure unique and different than every other bank, but put a 80% probability the issues abate.

Did You Know…?

Three Years Later

It was last Thursday that marked the three year anniversary of the bottom in stocks during the Covid pandemic on March 23, 2020. We write this note to remind clients, investors, and retirement savers, it is important to keep your long-term investment and retirement objectives in mind, especially in times of volatile periods, and how important it is to avoid making emotional decisions, despite how hard it may be. Prior to the Covid pandemic, stocks (as measured by the S&P 500) peaked on February 19, 2020 at 3,393.52. As the economy came to a standstill and over concerns of a deep economic recession, the index fell to a bottom of 2,191.86 on March 23, 2020, a 35.4% drop (actually in line with historical recessionary drawdowns). However, as the government stepped in to support individuals and businesses, and as investors realized it was a voluntary lockdown of the economy and demand would only be pushed into the future, stocks experienced one of the sharpest recoveries we have seen on record. By August, stocks had recover all of the losses, rising 55% from the lows. Then, as demand surged from the government printing money and the economy’s money supply rising 40%, stocks hit a new peak of 4,818.62 on January, 2022, an impressive 119.8% increase from the pandemic lows and an, also impressive, 42.0% increase from the pre-pandemic highs from February 2020. It was unprecedented times, but is a good reminder to always keep long-term goals/objectives in mind before making knee-jerk reactions. As always, we are here to answer any concerns that there may be and to help you navigate through these tough and volatile times.

WFG News

Updates on 2022 Tax Documents

Please note tax documents will not start mailing until January 31. Most retirement accounts will see 1099-R and form 5498 mailed on January 31. Retail accounts will see 1099 and related documents mailed by February 15. Certain accounts with more complex securities may have 1099’s mailed as late as March 15. Please see this email for more details. If there are any questions on tax documents, please reach out to us at 330-650-2700.

Regarding Market Conditions

We understand the volatility in the markets and headlines you see regarding the banking sector may be concerning. We expect further weakness in the markets in the weeks and months ahead as investors digest the collapse of several regional banks and the lingering effects on the economy/markets, but do not expect this to lead to a financial crisis or a similar event. However, an event like this will lead to further uncertainty and will have substantial effect on sentiment. We are working diligently to analyze all client portfolios and assessing ways to reduce risks and/or find opportunities. As always and particularly in instances such as this, it is important to not lose sight of your longer-term financial objectives.
If you have any questions or concerns in the meantime, please do not hesitate to reach out.

The Week Ahead

This week will be light on economic data and earning releases, with investors sure to be more focused on the banking sector and Federal Reserve policymaker’s comments instead. Following last week Fed’s meeting, there will be several Fed officials appearing in public speeches throughout the week where investors will look for additional signs on futures monetary policy and their thoughts on banking stability. Pertaining to the banking sector, Fed Vice Chair for Supervision Michael Barr and FDIC Chairman Martin Gruenberg will testify before Congress on the recent bank failures on Wednesday in which will shape the Federal regulatory response. The last week of the quarter has several earnings reports scheduled before a quiet week next week and first quarter earnings beginning the week after. Notable companies reporting include BioNTech, Carnival on Monday, Micron, Lululemon, Walgreens, McCormick on Tuesday, and Paychex on Wednesday. The highlight of the week on the economic calendar will be the monthly figures on personal income and consumer spending that will be released on Friday, where economists expect a 0.3% increase in income and 0.2% increase in spending for February, after an unusually strong January. Elsewhere, home prices via the Case Shiller home price index and the reading on consumer confidence for March will be released Tuesday, pending home sales on Wednesday, the final revision on fourth quarter GDP and jobless claims on Thursday, and the March read on consumer sentiment on Friday.