U.S. equities were mixed this week, as economic and market uncertainty increased substantially. Events in the banking sector and expected rise in interest rate drove volatility in equity markets. Friday was also a quarterly “triple witching” day, with three types of options and futures contracts expiring simultaneously, contributing to volatility to end the week.
The major indexes closed mixed for the week, reflecting the obstacles in the banking sector, worries of steeper slowdown in the economy, and hopes that the Federal Reserve would be forced to moderate or even pause in its rate hikes. By the end of the week, futures markets were pricing in zero likelihood of a 50-basis-point hike compared with a 40% chance of one the week before, according to CME Group data. Growth equities significantly outperformed value, communication services and technology shares recording strong gains, while financials and energy shares suffered significant losses. Treasuries were significantly firmer with the curve steepening. Prices of U.S. government debt surged for the second week in a row, sending yields sharply lower, with the steepest decline coming at the short end of the yield curve. After ending the previous week at 4.59%, the yield of the 2-year U.S. Treasury note fell to around 3.82% on Friday. As recently as March 8, it had been as high as 5.07%. The 2-year to 10-year spread notably narrowed after inverting the most since 1981 last week. The price of U.S. crude oil tumbled below $67 per barrel on Friday, slumping to the lowest level in more than 15 months. Oil fell around 13% for the week as instability in segments of the banking industry added to recessionary fears, which could weigh on demand for oil.
Analysts do not expect significant new banking legislation to be proposed. Instead, they estimate that regulators will propose increased capital requirements for regional banks. Most Republicans and some Democrats are skeptical that lax regulation was to blame for the collapses of SVB and Signature. Besides, legislation of any sort is difficult to pass when one party does not control all three branches of the federal government.
February’s inflation release shows that inflation remains too high. While the increase in February was less than in January, the fact is that inflation is well above what the Federal Reserve target is. February’s Consumer Price Index rose by 0.4% month over month at the headline level, after rising by 0.5% in January, and rose by 6% year over year. Energy prices fell slightly, declining for the third time in the past four months. The larger decline in household utility prices offset an increase in gasoline prices. Analysts expect inflation will moderate in 2023 but will take longer for inflation to get closer to the Fed’s 2% goal. The Fed is now much more focused on core services inflation which remains resilient. Services prices are largely determined by the labor market and nominal wage growth. Job growth momentum has moderated but not fast enough . Other data released last week showed that the headline PPI fell to 4.6% YoY from 5.7% the prior month, the lowest level since March 2021. Retail sales fell by 0.4% in February, after rising by 3.2% in January. Consumer spending appears to have moderated slightly but remains well above its historical trend.
This week, bond market volatility moved significantly higher as the upcoming Fed meeting next week gets closer. The recent bank adversities are possibly an indication that current FED policy might now be overly restrictive. Investors believe that the bond market is sending a strong message that the end of this rate-hiking cycle could be near. In the past 30 years, whenever the 2-year yield fell below the federal funds rate, it has signaled the end of fed hiking. Regardless of the outcome on the 22nd of March FOMC meeting, analysts believe that there will be a pause in rate hikes, as the Fed will need to monitor the financial stability situation.
Eurozone economic growth stalls while inflation remains elevated. The final number for eurozone fourth-quarter GDP growth was revised downward from 0.1% to 0.0%. In other words, the eurozone economy did not grow at all in the final three months of 2022—marking the first time this has happened since the second quarter of 2021. News on Wednesday that European banking giant Credit Suisse (CS) was also experiencing problems sent markets sharply lower again, although many observers pointed out that the Swiss bank’s problems were different in nature that the ones the U.S. banks are facing.
Equity and bond markets will be vulnerable due to elevated volatility until there’s a meaningful and consistent decrease in inflation, fill comfortable for the duration of higher rates and more certain about the “data-dependent” Fed rate hikes. We remain defensive in our positioning, and we’d look for opportunities to upgrade portfolios during market weakness. Within equities, we continue to favor U.S. Large Cap exposure. We’ve recently become more constructive on European equities, as the energy recession wasn’t as severe as anticipated. In the United States, large cap equities provide an attractive blend of quality, yield and high margins, even though earnings expectations continue to deteriorate. For fixed income, we remain defensive in our credit positioning, with at benchmark duration, and higher in credit quality.