Multiple risks are raising the stakes in financial markets and for the U.S. economy as Federal Reserve policy makers prepare to gather this week.The Fed is widely expected to deliver a quarter-of-a-percentage point interest rate hike when its meeting concludes on Wednesday. The most crucial question facing investors is whether policy makers subsequently show a willingness to hold off on further rate rises in order to assess the damage from their year-long campaign to lower inflation.
The numbers: The cost of goods and services rose a scant 0.1% in March and the yearly rate of inflation slowed again in response to higher interest rates and a cooler economy.
The increase in the so-called personal consumption expenditures index matched the Wall Street forecast. The PCE index is the Federal Reserve’s preferred inflation barometer.
Brent Schutte, chief investment officer at Northwestern Mutual Wealth Management Company, and Adam Crisafulli, Vital Knowledge Media president and founder, join ‘Closing Bell: Overtime’ to discuss how investors can approach the volatile market after a week of big earnings.
It was a two-week trading period like few had ever seen in the $24 trillion Treasury market.
In a span of roughly nine trading sessions between March 7 and 17, the yield on 2-year Treasury notes — a gauge of where U.S. central bankers are most likely to take interest rates over the next two years — sank a full percentage point to 3.85% from an almost 16-year closing high above 5%, with wide swings in both directions on the way down.
The 2-year yield’s yearlong upward trajectory made a sudden and dramatic descent, as investors swung from a view that interest rates would remain higher for longer to a scenario in which the Federal Reserve might need to cut borrowing costs to avert a deep recession and repeated bank failures. The wild swing in sentiment turned the 2-year Treasury rate TMUBMUSD02Y, 4.178%
into a roller-coaster ride and made it the most exciting space to watch in the traditionally staid government-debt market.
For traders like David Petrosinelli of InspereX in New York, a 25-year veteran of markets, March’s daily volatility was akin to “getting on an elevator with no buttons,” he said. He recalls telling people at his firm, who were worried about the positions they held at the time, that “a lot of this is a knee-jerk reaction to the unknown” — even if it felt both “eerily reminiscent” of rates volatility seen ahead of the 2007-2008 financial crisis, and “distinctly different’’ because it was driven by rapidly changing market expectations for the Fed and contained within the U.S. regional-banking system.
For more than a decade, there wasn’t much to say about the 2-year Treasury yield because the U.S. was mired in mostly low interest rates and “no one knew how to trade it,” according to Petrosinelli, 54, who began his career in the late 1990s as a as a portfolio manager focused on asset-backed and residential mortgage-backed securities. It was an overlooked rate in a sleepy corner of the market and nobody paid it much attention. That changed beginning in 2022, when monetary policy makers finally undertook the most aggressive rate-hike campaign in four decades to combat inflation — reinforcing the 2-year yield’s role as the best proxy for where the market thinks interest rates will end up. The 2-year yield rocketed to above 5% in early March from 0.15% in April 2021.
Suddenly, the 2-year Treasury became the most watched financial indicator on Wall Street, influencing the trajectories of stocks and the U.S. dollar throughout much of 2022. “This thing is relentless,” declared market commentator Jim Cramer on CNBC last year. He told viewers he was buying 2-year notes, not meme stocks. “The run to 4 is probably the most punishing one I can recall for the 2-year.” Other prominent names like Mohamed El-Erian, the former chief executive of PIMCO, and Jeffrey Gundlach, founder of DoubleLine Capital, wanted to talk about it. “If you want to know what’s going to happen in the year, follow the 2-year yield at this point,” El-Erian said on CNBC. “That’s the market indicator that has the most information.” More hedge funds and macro private-equity firms jumped on board and started trading it, said InspereX’s Petrosinelli. And head trader John Farawell of Roosevelt & Cross in New York, said family and friends who never showed much interest in fixed income before began regularly asking him if it was the right time to buy the 2-year Treasury note.
“Once we started to hit 4% on the 2-year yield last September for the first time since 2007, everyone got interested,” said Farawell, 66, a trader for the past 41 years. He estimates that interest in the 2-year yield among his firm’s clients has gone up about 30% in the past 12 months. “We have seen retail customers suddenly saying they want to put their money to work in the 2-year note because of an interest rate that we have not seen in years.”
From his office in Midtown Manhattan, Nicholas Colas noticed an abrupt and unexpected shift over the past year and it had to do with the 2-year Treasury. As the co-founder of DataTrek Research, a Wall Street research firm, Colas realized that the 2-year Treasury yield was influencing trading in the stock market. When the 2-year Treasury yield shot higher in 2022, the equity market would become volatile and often drop. In fact, the 2-year Treasury seemed to influence equity-market volatility in both directions. Whenever the 2-year yield briefly stabilized, Colas said, stocks tended to rally since equity investors took the stabilization in the 2-year rate to mean that Fed policy was “no longer as much of a wild card.”
To Colas, equity markets appeared to be taking any selloff in the 2-year note, and thus a rise in its corresponding yield, as a sign that the Fed would have to increase interest rates by more than expected and keep them higher for longer. With stocks and U.S. government debt both getting trounced regularly in last year’s selloffs, Colas said his first thought was that “all of a sudden, Treasurys were no longer a safe haven — something that has rarely happened since I started my career in 1983.”
Trading in government debt, like elsewhere in financial markets, is a two-way street of buyers and sellers. When yields are moving higher, that means the price of the corresponding Treasury security is dropping — and vice versa. The 2-year Treasury note pays out a fixed interest rate every six months until it matures. The trick to trading it, as opposed to buying and holding, is to either sell it before its underlying value gets destroyed by higher interest rates, or to buy it before the Fed starts cutting rates — which would, theoretically, produce a lower yield and make the government note more expensive.
Throughout the yield’s march higher, investors sold off the underlying 2-year note — a move which diminished the note’s value for existing holders like banks, pension funds, credit unions, foreign central banks, and U.S. corporations. Two-year Treasury notes also constitute about 1% to 2% of the total holdings at the 10 largest actively managed money-market funds, according to Ben Emons, senior portfolio manager and head of fixed income at NewEdge Wealth in New York.
“Policy expectations are what really drive the 2-year yield,” said Thomas Simons, a U.S. economist at Jefferies, one of the two dozen primary dealers that serve as trading counterparties of the Fed’s New York branch and help to implement monetary policy. “We had a major paradigm shift in terms of what investors’ expectations were for the sustainability of higher inflation and what the Fed would do in response. The impact on markets has been far less appetite for risk than there otherwise would be,” with stocks putting in a dismal performance in 2022, though generating somewhat better 2023 returns. Tucked into the note’s selloff, though, was plenty of interest from prospective government-debt buyers, which helped temper the magnitude of the 2-year yield’s rise once the rate got to 4%. Many looking to buy were individual investors hoping to benefit from higher yields and to diversify away from stocks, said traders like Tom di Galoma, a managing director for financial services firm BTIG.
Historically, banks, mutual funds, hedge funds, foreign investors and even the Fed have been the biggest buyers of Treasurys across the board; some of those players, particularly foreign central banks and money-market mutual funds, are mandated to buy and hold government debt. All two dozen primary dealers are involved as market makers for the 2-year security, stepping in to buy it in the absence of either direct or indirect buyers.
The 2-year note remains a reliable source of funding for the U.S. government, given the consistent demand for the maturity, which enables the U.S. Treasury Department to “raise a lot of cash quickly, if needed,” said Simons of Jefferies. In 2020, for example, when the government authorized $2.4 trillion in Covid-related spending and relief programs, the amount of 2-year notes sold at auction was one of the biggest of any maturity — far exceeding the 10- and 30-year counterparts — “because it had the capacity to handle that.’’
Sources: Treasury Department, Bureau of Public Debt, Federal Reserve Bank of Dallas.
Currently, the Treasury has $1.421 trillion in total outstanding 2-year notes, representing about 13% of all the debt issued out to 10 years, according to Treasurydirect.gov. The most recent 2-year note auction in March was for $42 billion — more than the 10-year note sale.
Fallout from the banking sector and worries about a potential recession altered the trajectory of the 2-year starting in March, triggering concerns that the Fed’s rate-hike cycle had gone too far. Fresh buyers poured into the 2-year space and pushed the yield below 4% — driven by the view that rates weren’t likely to go much higher from here and that policy makers might cut them by year-end.
Substantial downside volatility in the 2-year Treasury yield has actually helped to stabilize stock prices this year, in Colas’ estimation, because it’s been interpreted as the bond market’s sign that the Fed is approaching the end of its rate-hiking cycle.Like InspereX’s Petrosinelli, Colas says he had visions of the 2007-2008 financial crisis during March’s flight-to-quality trade, which occurred amid regional bank failures and “significantly more stress than the market was expecting.”
As of Thursday morning, the 2-year rate was at 4.17%, below the Fed’s benchmark interest-rate target range — implying that traders still believe policy makers will follow through with rate cuts. That’s a turnabout from the thinking that prevailed over most of 2022 through early last month, when the 2-year rate had been on an aggressive march toward 5% as the Fed continued to hike rates to combat inflation.
Meanwhile, poor liquidity continues to plague the Treasury market broadly, based on Bloomberg’s U.S. Government Securities Liquidity Index, which measures prevailing conditions. According to the New York Fed, the Treasury market was relatively illiquid throughout last year — making it more difficult to trade. As a result, there was a widening in the bid-ask spread — or difference between the highest price a buyer is willing to pay versus the lowest price a seller is willing to accept — of the 2-year note relative to its average.
“The volatility we’re seeing in the 2-year, we think, is largely a function of uncertain Fed rate hiking expectations coupled with poor liquidity,” said Lawrence Gillum, the Charlotte, N.C.-based chief fixed income strategist at LPL Financial.
“The 2-year is the most sensitive to changing policy expectations and since this Fed is ‘data dependent,’ any and all new data that could potentially change the inflation/economic growth narrative has increased volatility substantially,” Gillum said in an email. “As the Fed’s rate hiking campaign comes to an end (we think there is one more hike and then they’ll be done), we would expect the volatility to decline. Moreover, the Treasury and Fed are looking at ways to improve liquidity, but so far nothing has happened. Hopefully, they will do something, though, since the Treasury market is arguably the most important market in the world.”
At InspereX, Petrosinelli regards the 2-year note as an “anchor” to any short-term portfolio, and says that “it’s not a bad place for investors to hide out for at least a year.’’ That’s because even if the yield does come down, “investors wouldn’t be getting too hurt price-wise,” he said. “We think the Fed will leave rates elevated for some time.”
However, the 2-year could continue to dip below the fed-funds rate on soft economic data, especially related to consumption, later this year, Petrosinelli said. In order for the 2-year rate to go above the Fed’s main interest-rate target — now between 4.75% and 5% — “people would have to think the Fed is behind the curve again on inflation.”
For Farawell of Roosevelt & Cross, which was founded in 1946 and is one of Wall Street’s oldest independently owned municipal-bond underwriters, the 2-year note “has become such an attractive asset class for us’’ that “you almost can’t go wrong with putting money in it.” Friends and family “ask me about this 2-year and say, ‘It sounds good.’ I say, ‘It’s a great rate, you should buy it — until the Fed starts to change course.’”
Here’s a thought for investors: If the Federal Reserve raises interest rates to 5% or more would that wreck the economy and stock prices ?
The U.S. stock market has been rallying to start 2023, clawing back a big chunk of the painful losses from a year ago. The bullish tone has been linked to a view that the Federal Reserve will need to cut interest rates this year to prevent a recession, reversing one of its quickest rate-increasing campaigns in history.
Doomsday investors, including hedge-fund billionaire Paul Singer, have been warning against that outcome. Singer thinks a credit crunch and deep recession may be necessary to purge dangerous levels of froth in markets after an era of near-zero interest rates.
Another scenario might be that little changes: Credit markets could tolerate interest rates that prevailed before 2008. The Fed’s policy rate could increase a bit from its current 4.75%-5% range, and stay there for a while.
“A 5% interest rate is not going to break the market,” said Ben Snider, managing director, and U.S. portfolio strategist at Goldman Sachs Asset Management, in a phone interview with MarketWatch.
Snider pointed to many highly rated companies which, like the majority of U.S. homeowners, refinanced old debt during the pandemic, cutting their borrowing costs to near record lows. “They are continuing to enjoy the low rate environment,” he said.
“Our view is, yes, the Fed can hold rates here,” Snider said. “The economy can continue to grow.”
Profits margins in focus
The Fed and other global central banks have been dramatically increasing interest rates in the aftermath of the pandemic to fight inflation caused by supply chain disruptions, worker shortages and government spending policies.
Fed Governor Christopher Waller on Friday warned that interest rates might need to increase even more than markets currently anticipate to restrain the rise in the cost of living, reflected recently in the March consumer-price index at a 5% yearly rate, down to the central bank’s 2% annual target.
The sudden rise in interest rates led to bruising losses in stock and bond portfolios in 2022. Higher rates also played a role in last month’s collapse of Silicon Valley Bank after it sold “safe,” but rate-sensitive securities at a steep loss. That sparked concerns about risks in the U.S. banking system and fears of a potential credit crunch.
“Rates are certainly higher than they were a year ago, and higher than the last decade,” said David Del Vecchio, co-head of PGIM Fixed Income’s U.S. investment grade corporate bond team. “But if you look over longer periods of time, they are not that high.”
When investors buy corporate bonds they tend to focus on what could go wrong to prevent a full return of their investment, plus interest. To that end, Del Vecchio’s team sees corporate borrowing costs staying higher for longer, inflation remaining above target, but also hopeful signs that many highly rated companies would be starting off from a strong position if a recession still unfolds in the near future.
“Profit margins have been coming down (see chart), but they are coming off peak levels,” Del Vecchio said. “So they are still very, very strong and trending lower. Probably that continues to trend lower this quarter.”
Net profit margins for the S&P 500 are coming down, but off peak levels
Refinitiv, I/B/E/S
Rolling with it, including at banks
It isn’t hard to come up with reasons why stocks could still tank in 2023, painful layoffs might emerge, or trouble with a wall of maturing commercial real estate debt could throw the economy into a tailspin.
Snider’s team at Goldman Sachs Asset Management expects the S&P 500 index SPX, -0.21%
to end the year around 4,000, or roughly flat to it’s closing level on Friday of 4,137. “I wouldn’t call it bullish,” he said. “But it isn’t nearly as bad as many investors expect.”
“Some highly levered companies that have debt maturities in the near future will struggle and may even struggle to keep the lights on,” said Austin Graff, chief investment officer at Opal Capital.
Still, the economy isn’t likely to “enter a recession with a bang,” he said. “It will likely be a slow slide into a recession as companies tighten their belts and reduce spending, which will have a ripple effect across the economy.”
However, Graff also sees the benefit of higher rates at big banks that have better managed interest rate risks in their securities holdings. “Banks can be very profitable in the current rate environment,” he said, pointing to large banks that typically offer 0.25%-1% on customer deposits, but now can lend out money at rates around 4%-5% and higher.
“The spread the banks are earning in the current interest rate market is staggering,” he said, highlighting JP Morgan Chase & Co. JPM, +7.55%
providing guidance that included an estimated $81 billion net interest income for this year, up about $7 billion from last year.
Del Vecchio at PGIM said his team is still anticipating a relatively short and shallow recession, if one unfolds at all. “You can have a situation where it’s not a synchronized recession,” he said, adding that a downturn can “roll through” different parts of the economy instead of everywhere at once.
The U.S. housing market saw a sharp slowdown in the past year as mortgage rates jumped, but lately has been flashing positive signs while “travel, lodging and leisure all are still doing well,” he said.
U.S. stocks closed lower Friday, but booked a string of weekly gains. The S&P 500 index gained 0.8% over the past five days, the Dow Jones Industrial Average DJIA, -0.42%
advanced 1.2% and the Nasdaq Composite Index COMP, -0.35%
closed up 0.3% for the week, according to FactSet.
Investors will hear from more Fed speakers next week ahead of the central bank’s next policy meeting in early May. U.S. economic data releases will include housing-related data on Monday, Tuesday and Thursday, while the Fed’s Beige Book is due Wednesday.
The U.S. economy could slip into recession given the fast pace of interest rate rates over the past year, said Chicago Fed President Austan Goolsbee on Friday.
“There is no way you can look at current conditions around the U.S. and not think that some mild recession is on the table as a possibility,” Goolsbee said, in an interview on CNBC.
At the same time, while inflation is coming down, there is “clear stickiness” in some categories of prices, he said.
Goolsbee said he is focused on whether there is a credit crunch in the wake of the collapse of Silicon Valley Bank in March.
The Chicago Fed president, who is a voting member of the Fed’s interest rate committee, said he wanted to see more data before deciding what to do at the Fed’s next meeting on May 2-3 .
“What I am looking at quite clearly coming into the next FOMC meeting is what’s happening on credit…how much of a credit crunch is there,” he said.
“Let’s be mindful that we’ve raised a lot. It takes time for that to work its way through the system,” Goolsbee said.
The March retail sales report, released earlier this morning, might be a sign of further slowing in the economy, he said. The government reported a 1% drop in retail sales, the biggest decline since November.
“If you add financial stress on top of that, let’s not be too aggressive,” he said.
U.S. stock indexes traded mostly higher on Tuesday as investors cautiously looked ahead to March’s inflation data due Wednesday that could determine the Federal Reserve’s next interest-rate move, as well as to the start of the corporate earnings reporting season on Friday.
How are stock indexes trading
The S&P 500 SPX, -0.00%
rose 14 point, or 0.4%, to 4,123
Dow Jones Industrial Average DJIA, +0.29%
added 176 points, or 0.5%, to 33,763
Nasdaq Composite COMP, -0.43%
dropped 3 points, or less than 0.1%, to 12,081
On Monday, the Dow Jones Industrial Average rose 101 points, or 0.3%, to 33,587, the S&P 500 increased 4 points, or 0.1%, to 4,109, and the Nasdaq Composite dropped 4 points, or 0.03%, to 12,084.
What’s driving markets
Wall Street’s main stock indexes mostly advanced Tuesday afternoon, as investors awaited the release of March’s consumer price index and the start of the first-quarter earnings season, with the banking sector slated to report numbers later this week.
The S&P 500 index sits less than 0.5% off its best level since mid-February as investors have become more relaxed about prospects for the U.S. economy and more accepting of the path of Federal Reserve policy.
The March employment report released last Friday showed a steady pace of job creation but with no great sign of accelerating wage inflation, which helped calm fears of a sharp economic slowdown and faster Fed interest rate hikes.
But now attention turns to the March’s consumer price index report due Wednesday, which is seen as one of the last key data points before the Federal Reserve’s next interest-rate move.
The March CPI reading from the Bureau of Labor Statistics, which tracks changes in the prices paid by consumers for goods and services, is expected to show a 5.2% rise from a year earlier, slowing from a 6% year-over-year rise in the previous month, according to a survey of economists by Dow Jones.
Core CPI, which strips out volatile food and fuel costs, is expected to rise 0.4% from a month ago, or 5.6% year over year. The increase in the core rate over the 12-month period dipped to 5.5% in February.
Investors are wondering whether the Fed is satisfied with what it has done to fight inflation, and whether the central bank has done too much that it would drag the U.S. economy into a recession, according to Kristina Hooper, chief global market strategist at Invesco.
“Tomorrow’s data point will only help us answer that first question,” Hopper said. Meanwhile, “while CPI is important, it’s just one data point. Hopefully it will confirm what we’ve seen with other data points that there’s significant progress in fighting inflation, and hopefully that’s enough to satisfy the Fed,” Hooper said in a call.
Seema Shah, chief global strategist at Principal Asset Management, expects the decline in inflation in 2023 will likely be “incomplete with inflation remaining above central bank targets,” complicating its policy decisions.
“Global inflation is moderating, but so far this deceleration has been largely driven by last year’s energy price spike unwind. Core inflation remains uncomfortably high and, in some economies, continues to rise,” Shah said in emailed comments on Tuesday.
“Central banks have made less progress towards disinflation than they had hoped. Inflation is likely to remain sticky and will still sit above central bank targets at year-end,” Shah said.
The U.S. and global economies are likely to struggle to grow over the next few years as countries fight to reduce high inflation and cope with rising interest rates, the International Monetary Fund said Tuesday.
Meanwhile, the IMF said recent stress in the banking sector could reduce the ability of U.S. banks to lend over the next year, and materially lower U.S. economic growth.
The IMF estimated that lending capacity in the U.S. could fall by almost 1% in the coming year. That would reduce U.S. real gross domestic product by 44 basis points over that time frame, all else being equal, the IMF said.
Then, on Friday, the first-quarter corporate earnings season kicks into gear with the’ financial sector in the vanguard.
It’s particularly important to pay attention to earnings calls and guidance provided by companies’ management, noted Hooper. “That to me is where we’re likely to get the best insights or at least the most robust insights into current credit conditions, to understand what could happen to the economy,” Hooper said.
Philadelphia Fed President Harker will be speaking at 6:30 p.m. and Minneapolis Fed President Kashkari is due to speak at 7:30 p.m. Both times Eastern.
National CineMedia Inc. shares NCMI, +54.96%
shot up 58% after movie theater operator AMC Entertainment Holdings Inc. AMC, +3.63%
disclosed that it has taken a 9.1% stake in the cinema advertising platform. AMC shares jumped 5.9%.
Virgin Orbit Holdings Inc.’s stock VORB, -29.55%
plunged 32% premarket after announcing last Monday that the exchange would delist the space launch companies’ shares after it filed for Chapter 11 bankruptcy protection last week.
The U.S. and global economies are likely to struggle to grow over the next few years as countries fight to reduce high inflation and cope with rising interest rates, the IMF said Tuesday.
The latest projections paint a gloomy picture of the challenges facing the world. Chief among them is high inflation, a problem the IMF said has proven stickier than expected compared to “even a few months ago.”
Price increases in goods and services other than food and gasoline are still high, the IMF said, and a tight labor market could keep upward pressure on wages.
Inflation globally is likely to average about 7% in 2023, up almost 1/2 point from the IMF estimate just three months ago.
The fund said inflation probably won’t return to the low levels that prevailed around the world until “2025 in most cases.” In the U.S., for example, inflation rose less than 2% a year in the decade before the pandemic.
Stubbornly high inflation, in turn, is likely to force the U.S. and other countries to keep interest rates high for some time.
“This may call for monetary policy to tighten further or to stay tighter for longer than currently anticipated,” IMF director of research Pierre-Olivier Gourinchas said.
Yet rising interest rates and higher borrowing costs also risk destabilizing financial institutions as witnessed by the failure of Silicon Valley Bank in the U.S. and the emergency rescue of Switzerland-based Credit Suisse.
“Once again, the financial system may well be tested even more,” he added. “Nervous investors often look for the next weakest link, as they did with Crédit Suisse.”
IMF
Threats to banks could add to the stress on the economy by spurring them to lend less to businesses and consumers. Lending is critical for economic growth.
“We are therefore entering a tricky phase during which economic growth remains lackluster by historical standards, financial risks have risen, yet inflation has not yet decisively turned the corner,” Gourinchas said.
The U.S. economy is forecast to slow from 2.1% growth in 2022 to 1.6% in 2023 and 1.1% in 2024. Notably, the IMF does not predict a U.S. recession.
By contrast, the Federal Reserve predicts U.S. growth will slow to just 0.4% in 2023 and then rebound to a 1.2% annual pace in 2024.
Most countries in Europe are also expected to keep growing aside from the U.K. and Germany, whose economies have been harder hit by high energy prices.
The world economy is forecast to expand 2.8% in 2023 and 3% in 2024, a shade lower compared to the IMF’s forecast in at the start of the year.
Looking out to 2028, global growth is forecast at 3%, the weakest five-year outlook since the IMF began publishing them 33 years ago.
A version of this story first appeared in CNN Business’ Before the Bell newsletter. Not a subscriber? You can sign up right here. You can listen to an audio version of the newsletter by clicking the same link.
New York CNN
—
In an unusual coincidence, the US jobs report was released on a holiday Friday — meaning stock markets were closed when the closely-watched economic data came out.
It was the first monthly payroll report since Silicon Valley Bank and Signature Bank collapsed. It also marked a full year of jobs data since the Federal Reserve began hiking interest rates in March 2022.
While inflation has come down and other economic data point to a cooling economy, the labor market has remained remarkably resilient.
Investors have had a long weekend to chew over the details of the report and will likely skip the typical gut-reaction to headline numbers.
What happened: The US economy added 236,000 jobs in March, showing that hiring remained robust though the pace was slower than in previous months. The unemployment rate currently stands at 3.5%.
Wages increased by 0.3% on the month and 4.2% from a year ago. The three-month wage growth average has dropped to 3.8%. That’s moving closer to what Fed policymakers “believe to be in line with stable wage and inflation expectations,” wrote Joseph Brusuelas, chief economist at RSM in a note.
“That wage data tends to suggest that the risk of a wage price spiral is easing and that will create space in the near term for the Federal Reserve to engage in a strategic pause in its efforts to restore price stability,” he added.
The March jobs report was the last before the Fed’s next policy meeting and announcement in early May. The labor market is cooling but not rapidly or significantly, and further rate hikes can’t be ruled out.
At the same time Wall Street is beginning to see bad news as bad news. A slowing economy could mean a recession is forthcoming.
Markets are still largely expecting the Fed to raise rates by another quarter point. So how will they react to Friday’s report?
Before the Bell spoke with Michael Arone, State Street Global Advisors chief investment strategist, to find out.
This interview has been edited for length and clarity.
Before the Bell: How do you expect markets to react to this report on Monday?
Michael Arone: I think that this has been a nice counterbalance to the weaker labor data earlier last week and all the recession fears. This data suggests that the economy is still in pretty good shape, 10-year Treasury yields increased on Friday indicating there’s less fear about an imminent recession.
There’s this delicate balance between slower job growth and a weaker labor market without economic devastation. I think this report helps that.
As it relates to the stock market, I would expect the cyclical sectors to do well — your industrials, your materials, your energy companies. If interest rates are rising, that’s going to weigh on growth stocks — technology and communication services sectors, for example. Less recession fears will mean investors won’t be as defensively positioned in classic staples like healthcare and utilities.
Could this lead to a reverse in the current trend where tech companies are bolstering markets?
Yes, exactly. It’s difficult to make too much out of any singular data point, but I think this report will hopefully lead to broader participation in the stock market. If those recession fears begin to abate somewhat, and investors recognize that recession isn’t imminent, there will be more investment.
What else are investors looking at in this report?
We’ve seen weakness in the interest rate sensitive parts of the market — areas that are typically the first to weaken as the economy slows down. So things like manufacturing, things like construction. That’s where the weakness in this jobs report is. And the services areas continue to remain strong. That’s where the shortage of qualified skilled workers remains. I think that you’re seeing continued job strength in those areas.
What does this mean for this week’s inflation reports? It seems like the jobs report just pushed the tension forward.
it did. I expect that inflation figures will continue to decelerate — or grow at a slower rate. But I do think that the sticky part of inflation continues to be on the wage front. And so I think, if anything, this helps alleviate some of those inflation pressures, but we’ll see how it flows through into the CPI report next week. And also the PPI report.
Is the Federal Reserve addressing real structural changes to the labor market?
The Fed was confused in February 2020 when we were in full employment and there was no inflation. They’re equally confused today, after raising rates from zero to 5%, that we haven’t had more job losses.
I’m not sure why, but from my perspective, the Fed hasn’t taken into consideration the structural changes in the labor force, and they’re still confused by it. I think the risk here is that they’ll continue to focus on raising rates to stabilize prices, perhaps underestimating the kind of structural changes in the labor economy that haven’t resulted in the type of weakness that they’ve been anticipating. I think that’s a risk for the economy and markets.
A few weeks ago, Before the Bell wrote about big problems brewing in the $20 trillion commercial real estate industry.
After decades of thriving growth bolstered by low interest rates and easy credit, commercial real estate has hit a wall. Office and retail property valuations have been falling since the pandemic brought about lower occupancy rates and changes in where people work and how they shop. The Fed’s efforts to fight inflation by raising interest rates have also hurt the credit-dependent industry.
Recent banking stress will likely add to those woes. Lending to commercial real estate developers and managers largely comes from small and mid-sized banks, where the pressure on liquidity has been most severe. About 80% of all bank loans for commercial properties come from regional banks, according to Goldman Sachs economists.
Since then, things have gotten worse, CNN’s Julia Horowitz reports.
In a worst-case scenario, anxiety about bank lending to commercial real estate could spiral, prompting customers to yank their deposits. A bank run is what toppled Silicon Valley Bank last month, roiling financial markets and raising fears of a recession.
“We’re watching it pretty closely,” said Michael Reynolds, vice president of investment strategy at Glenmede, a wealth manager. While he doesn’t expect office loans to become a problem for all banks, “one or two” institutions could find themselves “caught offside.”
Signs of strain are increasing. The proportion of commercial office mortgages where borrowers are behind with payments is rising, according to Trepp, which provides data on commercial real estate.
High-profile defaults are making headlines. Earlier this year, a landlord owned by asset manager PIMCO defaulted on nearly $2 billion in debt for seven office buildings in San Francisco, New York City, Boston and Jersey City.
Tech stocks led market losses in 2022, but seemed to rebound quickly at the start of this year. So as we enter earnings season, what should we expect from Big Tech?
Daniel Ives, an analyst at Wedbush Securities, says that he has high hopes.
“Tech stocks have held up very well so far in 2023 and comfortably outpaced the overall market as we believe the tech sector has become the new ‘safety trade’ in this overall uncertain market,” he wrote in a note on Sunday evening.
Even the recent spate of layoffs in Big Tech has upside, he wrote.
“Significant cost cutting underway in the Valley led by Meta, Microsoft, Amazon, Google and others, conservative guidance already given in the January earnings season ‘rip the band- aid off moment’, and tech fundamentals that are holding up in a shaky macro[environment] are setting up for a green light for tech stocks.”
A version of this story first appeared in CNN Business’ Before the Bell newsletter. Not a subscriber? You can sign up right here. You can listen to an audio version of the newsletter by clicking the same link.
New York CNN
—
There’s been a seismic shift in investor perspective: Bad news is no longer good news.
For the past year, Wall Street has hoped for cool monthly economic data that would encourage the Federal Reserve to haltits aggressive pace of interest rate hikes to tame inflation.
But at its March meeting — just days after a series of bank failures raised concerns about the economy’s stability — the central bank signaled that it plans to pause raising rates sometime this year. With an end to interest rate hikes in sight, investors have stopped attempting to guess the Fed’s next move and have turned instead to the health of the economy.
This means that,whereas softening economic data used to signal good news — that the Fed could potentially stop raising rates — now, cooling economic prints simply suggest the economy is weakening. That makes investors worried that the slowing economy could fall into a recession.
What happened last week? Markets teetered after a slew of economic reports signaled that the red-hot labor market is finally cooling (more on that later), flashing warning signals across Wall Street.
Investors accordingly shed high-growth, large-cap stocks that have surged recently to rush into defensive stocks in industries like health care and consumer staples.
While tech stocks recovered somewhat by the end of the short trading week — markets were closed in observance of Good Friday — the Nasdaq Composite still slid 1.1%. The broad-based S&P 500 fell 0.1% and the blue-chip Dow Jones Industrial Average gained 0.6%.
What does this mean for markets? Now that Wall Street is in “bad news is bad news and good news is good news” mode, it will be looking for signs that the economy remains resilient.
What hasn’t changed is that investors still want to see cooling inflation data. While the central bank has signaled that it will pause hiking rates this year, its actions so far haveonly somewhat stabilized prices. The Personal Consumption Expenditures price index, the Fed’s preferred inflation gauge, rose 5% for the 12 months ended in February — far above its 2% inflation target.
Moreover, Wall Street might be overly optimistic about how the Fed will act going forward: Some investors expect the central bank to cut rates several times this year, even though the central bank indicated last month that it does not intend tolower rates in 2023.
It’s unclear how markets will react if the Fed doesn’t cut rates this year. But there likely won’t be a notable rally unless the central bank pivots or at least indicates that it plans to soon, said George Cipolloni, portfolio manager at Penn Mutual Asset Management.
Commentary that’s hawkish or reveals inflation worries could hurt markets, he adds. “It keeps that boiling point and that temperature a little high.”
What comes next? The Fed holds its next meeting in early May. Before then, it will have to parse through several economic reports to get a sense of how the economy is doing, and what it will be able to handle. Markets currently expect the Fed to raise interest rates by a quarter point, accordingto the CME FedWatch tool.
The labor market appears to be cooling somewhat, at least according to the slew of data released last week. But it’s still far too early to assume that the job market has lost its strength.
President Joe Biden said in a statement Friday that the March data is “a good jobs report for hard-working Americans.”
The March jobs report revealed that US employers added a lower-than-expected 236,000 jobs last month. Economists expected a net gain of 239,000 jobs for the month, according to Refinitiv.
The unemployment rate dropped to 3.5%, according to the Bureau of Labor Statistics. That’s below expectations of holding steady at3.6%.
The jobs report was also the first one in 12 months that came in below expectations.
But that doesn’t mean that the job market isn’t strong anymore.
“The labor market is showing signs of cooling off, but it remains very tight,” Bank of America researchers wrote in a note Friday.
Still, other data released last week help make the case that cracks are finally starting to form in the labor market. The Job Openings and Labor Turnover Survey for February revealed last week that the number of available jobs in the United States tumbled to its lowest level since May 2021. ADP’s private-sector payroll report fell far short of expectations.
What this means for the Fed is that the cooldown in the latest jobs report likely won’t be enough for the central bank to pause rates at its next meeting.
“The Fed will more than likely raise rates in May as the labor market continues to defy the cumulative effects of the rate hikes that began over a year ago,” said Quincy Krosby, chief global strategist at LPL Financial.
First-quarter earnings season kicks off this week. Results from big U.S. banks later in the week will be heavily scrutinized for the impact of the past month’s turmoil in the sector. Economic-data highlights will include the latest inflation data and minutes from the Federal Open Market Committee’s late-March meeting.
In the wake of the collapse of Silicon Valley Bank, conventional wisdom has been that banks will cut lending, known as a credit crunch, that will damage the economy.
On Thursday, St. Louis Federal Reserve President James Bullard said he was “less enamored’ with this forecast.
“Only about 20% of lending is going through the banking system…
The Federal Reserve’s overnight repo facility has been utilized by money market funds to a large extent, and may be contributing to dramatic outflows of deposits from banks since the failure of Silicon Valley Bank and Signature Bank last month.
Bloomberg News
Deposit flows after a pair of high-profile bank failures last month have renewed a debate about the Federal Reserve’s support of money market funds and whether that support harms banks.
Between March 8 and March 22, total commercial bank deposits declined by $300 billion, according to Fed data. During that same period, money market funds ticked up $238 billion.
It is unclear how many of those deposits went directly from banks to money market funds, but some in and around the banking sector worry that the Fed’s Overnight Reverse Repurchase Program has made it easier for funds to move in that direction.
Also known as the ON RRP, the facility allows money market funds and other entities to purchase securities from the Fed and sell them back the next day at a fixed, higher price. Between March 8 and March 22, total ON RRP usage — which includes activity by government-sponsored entities and some banks — only increased by $47 billion. But since March 2021, the facility has swollen from zero to roughly $2.2 trillion per day, and has remained at that level since last June.
Some of the sharpest criticism of the facilities growth has come from the Bank Policy Institute, a bank lobbying organization, which accused the Fed last week of “abetting a draining of deposits from banks.”
Policy experts outside the banking industry also say the Fed’s engagement with money market funds, through both its ON RRP facility and other actions, have given those funds advantages over banks, ones that do not always benefit the broader economy.
“The whole [ON RRP] facility should be unwound,” Karen Petrou, managing partner of Federal Financial Analytics, said. “Similarly, the Fed should stop sitting on trillions in bank deposits. It’s a huge distortion.”
Historically, money market funds have increased the availability of credit by purchasing short term corporate loans — known as commercial paper — and Treasury bills, which are government bonds with maturities of less than one year. Funds still engage in this activity, but their ability to earn interest simply by engaging in these purchase agreements with the Fed diminishes their economic impact, Petrou said.
“The Fed is supporting funds flowing out of the banking system, where they support macroeconomic activities, into the funds sector, then looping them back into the Fed where they support the Fed’s portfolio and government borrowing,” she said. “That’s a really altered state that nobody’s quite focused on.”
Fed officials, including Gov. Christopher Waller, have described increased use of the ON RRP facility — which has primarily been driven by money market funds — as excess liquidity in the financial system. Because of this, he said, the $2 trillion regularly tied up in that facility could be shed from the Fed’s balance sheet with little consequence.
However, some economists worry what the growth of that facility will mean for bank funding, especially if economic conditions worsen. To this, Waller has said it will be up to the banks to attract depositors back from funds by paying higher interest rates.
“At some point, as reserves are draining out, it’ll come out of the banks and then the banks, if they need reserves, it’s sitting over there on this ON RRP being handed over by money market mutual funds,” he said during a public appearance in January. “You’re going to have to go compete to get those funds back.”
But doing so may be easier said than done, given how many bank balance sheets are weighed down by long-duration legacy assets — loans and securities — that are paying low fixed rates. If banks start paying more to depositors, they diminish the net interest margins that support their profitability.
This could be especially problematic for banks that see outflows of current depositors who are being paid minimal interest on their deposits, said Michael Redmond, an economist with Medley Advisors who previously worked at Federal Reserve Bank of Kansas City and the U.S. Treasury.
“There’s a limit on how much banks can adjust their deposit rates higher if their existing deposit base does turnover, and that’s why a lot of economists think there is going to be credit contraction,” Redmond said. “Rather than only adjusting on the liability side of their balance sheet, banks might also try to curtail some of the activity on the asset side of their balance sheets as well.”
Money market funds tend to pay significantly higher interest rates than banks. This happens for a few key reasons.
The fund model is simpler than that of a bank. Funds profit off fees charged to investors who, in turn, are paid using proceeds from the fund’s investments. Banks, meanwhile, largely profit from the difference between the interest they collected from their assets and the amount paid out to depositors, also known as their net interest margin.
Instead of conducting maturity transformation — using short-term deposits to create long-term loans — money market funds use investor money to buy public or private debt. Because these funds invest in short-term instruments, investors are generally able to redeem their deposits at any time.
However, that redemption is not technically guaranteed. Money market funds are less tightly regulated than banks and they do not have to carry insurance for their deposits. This results in lower operating costs for funds relative to banks, but also increases the risk associated with their model. Investors, in theory, are paid a premium for taking on that additional risk.
But whether investments in money market funds are actually at risk is debatable, said Aaron Klein, a senior fellow at the Brookings Institution and a Treasury official during the Obama administration.
“For an institution run by economists, the Fed seems to struggle with the concept that greater return implies greater risk,” Klein said.
Following the collapse of the investment bank Lehman Brothers in 2008 and the onset of the COVID-19 pandemic in 2020, the Fed and the Treasury Department guaranteed money market investors that they would be made whole. The actions were taken under systemic risk declarations by the agencies to prevent a run by depositors.
Klein said these actions have signaled to market participants that money market funds will have the implicit backing of the federal government in times of distress. For uninsured depositors — such as those who fled Silicon Valley Bank last month — that not only made funds a more lucrative option, but also a potentially safer one, he said.
“Ask yourself today what is more implicitly guaranteed by the Federal Reserve: money market mutual funds or uninsured bank deposits? If you can’t find a difference in the level of implicit guarantee, that’s quite telling,” Klein said. “The Federal Reserve’s repeated bailouts of money market mutual funds, which are owned by the wealthy, makes our financial system less stable and, in the long run, our economy more unequal.”
The Fed created the ON RRP facility in 2013. The idea behind it was to create a channel through which the central bank could convey its monetary policy to market participants other than banks. It was conceived as the Fed was preparing to raise interest rates from their lower bound, where they had been since 2008.
Money market funds were not the intended beneficiary of the program, but they have taken advantage of it more than almost any other type of counterparty.
As a tool for implementing monetary policy, the facility has been effective, said Bill English, a finance professor at the Yale School of Management and a former monetary official at the Fed. But the program looks quite a bit different than when it was initially introduced.
Instead of setting the rate for the facility a quarter percentage point below the federal funds rate, the Fed now pays about 10 basis points less for its repurchases, English said. It also lifted the $300 billion cap that the program first featured and now offers unlimited use.
Like others, English says the facility could benefit from some revisions, such as a reducing the rate paid to counterparties. Doing so, he added, could be beneficial to the Fed’s monetary goals by allowing it to shrink its balance sheet more swiftly.
Ultimately, he said, banks should not count on changes to the Fed’s ON RRP facility changing the competitive landscape for deposits.
“Banks may have to get used to the idea that the safe, stable, low-cost funding that they get from their retail deposit franchise is just less than was the case 20 years ago,”English said. “And this interest rate cycle is showing that.”
Millions of jobs could be on the chopping block this year, as the Federal Reserve continues its rate-hiking campaign to tame inflation. But the effects of that action likely won’t reverberate evenly across the economy.
The Fed has seen some success: Inflation has cooled for eighth consecutive months, according to the February Consumer Price Index. The Producer Price Index shows a dramatic drop in wholesale prices in February. And the Fed’s favored inflation gauge, the Personal Consumption Expenditures price index, has also started to moderate.
But the job market has proved to be a formidable force, humming steadily in the face of climbing rates meant to slow its growth. After adding more than half a million jobs in January, the US economy then added 311,000 jobs in February, with an unemployment rate of 3.6% — just above a half-century low — according to the Bureau of Labor Statistics.
However, the jobless rate isn’t expected to be that low for long.
Atits most recent policy-making meeting, the Fed released projections for the year ahead that showed unemployment could jump to 4.5%, representing another 1.5 million job losses, by the end of the year.
While that’s a small improvement from the central bank’s previous 4.6% jobless rate estimate, economists say it’s possible the unemployment rate could rise above the Fed’s expectations. Moreover, they say that historically disadvantaged groups could be disproportionately affected by the central bank’s stringent monetary policy.
While some groups often sidelined in the job market have seen benefits from this hot job market — women have seen a faster pace of job gains than men in recent months, for example — others, including Black women and Latino men, have seen slower recoveries in jobless rates since the onset of the Covid pandemic.
Recession fears gained traction last month when the collapse of Silicon Valley Bank sent markets wobbling, raising concerns about the economy’s ability to handle more stress. Goldman Sachs revised its estimate of the United States entering a recession over the next 12 months to a 35% chance, up from its estimate of a 25% chance before the banking sector turmoil.
That’s of particular concern to certain demographic groups: Jobless rates for Black and Hispanic Americans often increase by more than those of their White counterparts during recessions, said Rakesh Kochhar, a senior researcher focusing on demographics and social trends at the Pew Research Center.
History makes that discrepancy clear.
A Pew Research Center report comparing two recessions in recent decades shows how Black and Hispanic Americans experience disproportionate effects on their jobless rates during periods of economic downturn. From the second quarter of 2007 to the second quarter of 2009, during the Great Recession, the unemployment rate rose 6.5 percentage points for Black Americans. The Hispanic unemployment rate climbed 6.3 percentage points. For White workers, it increased 4 percentage points.
And from the first quarter of 1990 to the first quarter of 1991, the unemployment rate climbed 1.4 percentage points for Black Americans and 2.1 percentage points for Hispanic Americans. The White unemployment rate rose 1.3 percentage points.
Economists say it’s hard to guess the trajectory of the unemployment rate this year, noting it could very well exceed the Fed’s estimate.
“There’s just tons of momentum, and once you slow the economy enough to get the unemployment rate moving up, it’s very hard to sort of turn that cruise ship back around,” said Josh Bivens, research director and chief economist at the Economic Policy Institute.
As such, the Fed’s tightening efforts could easily drive the Black unemployment rate much higher than the overall jobless rate, said William Spriggs, an economics professor at Howard University and chief economist to the AFL-CIO.
“If the Fed continues to use unemployment as its measure of labor force slack, and thinks they want a 4.5% unemployment rate — to make that happen, the Fed would have to induce net job loss in the labor market,” Spriggs told CNN in an email. “If we go through two months of negative job growth, all bets are off. The Black unemployment rate will easily get to 9% in that scenario.”
One other likely consequence of growing unemployment is slowing wage growth, Bivens said.
Like rising unemployment, stunted wage growth tends to hit marginalized groups harder. A 2021 Economic Policy Institute report shows that a 1 percentage point increase in overall unemployment correlates with about 0.5% slower wage growth for White median hourly wages. Wage growth falls by roughly 0.8% for Black median hourly wages.
“A lot of people have this idea that in a recession, if unemployment rises by a couple of percentage points, as long as you’re not one of those unlucky people to lose the job, you’ve dodged the bullet,” Bivens said. “And that’s not true at all.”
Still, a robust labor market isn’t a permanent solution to bridging employment disparities, even if the Fed does keep rates lower, says Wendy Edelberg, director of the Hamilton Project and a senior fellow in economic studies at the Brookings Institution.
The job market’s recent strength is unsustainable, she said. The US economy needs about 75,000 net job gains a month to keep stable and is currently adding about 350,000 net job gains a month on average, according to Edelberg.
“[The Fed is] right to be confident that one of the things that’s going to have to happen to get inflation back down to a normal, stable level is to get job growth to a normal, sustainable level,” Edelberg said. “But if the Fed’s actions resulted in a slower labor market, then inflation stayed high — that would be a disaster.”
The March jobs report from the Department of Labor, due to be released Friday at 8:30 a.m., is expected to show the US economy gained 240,000 positions last month. ADP’s private-sector payroll report, generally seen by investors as a proxy for the trajectory of Friday’s number, fell short of expectations, with just 145,000 jobs added. Economists had expected private hiring would rise by 200,000 positions last month.
The numbers: The cost of U.S. goods and services rose by a milder 0.3% in February, perhaps a sign the Federal Reserve’s fight against high inflation is showing grudging progress.
Prices had risen by a sharp 0.6% in January, based on the so-called PCE index.
The yearly increase in prices declined to 5% from 5.3% in the prior month, the government said Friday, marking the lowest level in more than a year and a half.
That’s still about three times the rate of inflation before the pandemic, however.
Senior Federal Reserve officials have signaled they plan to raise interest rates just once more before pausing to determine how much a sharp increase in borrowing costs brings down inflation. The Fed has jacked up its key short-term U.S. rate to a top end of 5%, a remarkably fast acceleration from nearly zero one year ago.
Higher interest rates temper inflation by slowing the economy, but the effects can sometimes take up to a year or more to be fully felt. The Fed wants to avoid going too far or cause any more stress on the U.S. financial system after the failure of Silicon Valley Bank.
Key details: The more closely followed core index also increased 0.3% last month, matching Wall Street’s forecast.
The core rate of inflation in the past 12 months slipped to 4.6% from 4.7%.
The PCE is viewed by the Fed as the best predictor of future inflation trends. It is formally known as the personal consumption expenditures price index.
The central bank pays especially close attention to the core gauge that strips out volatile food and energy costs.
Unlike it’s better-known cousin, the consumer price index, the PCE gauge takes into account how consumers change their buying habits due to rising prices.
They might substitute cheaper goods such as chicken thighs for more expensive ones like boneless breasts to keep costs down. Or buy generic medicines instead of brand names.
Big picture: The Fed is trying to straddle a fine line: Bring inflation back down to its 2% target, but without causing a severe economic reaction.
Whether the Fed will be able to hold the line on just one more rate hike is far from certain.
If inflation stays high, the central bank would have to end its pause on rate hikes and risk a recession. A slim majority of economists, in fact, already believe a downturn is imminent.
Steadily falling inflation, on the other hand, could allow the Fed to pull a rabbit out of the proverbial hat.
Looking ahead: “For an economy looking to avoid recession, this was a good report,” said Robert Frick, corporate economist at Navy Federal Credit Union.
“For the Fed, it could be one and done in May,” said senior economist Sal Guatieri of BMO Capital Markets.
Market reaction: The Dow Jones Industrial Average DJIA, +0.50%
and S&P 500 SPX, +0.57%
rose in Friday trades. The yield on the 10-year Treasury note TMUBMUSD10Y, 3.535%
declined several basis points to 3.53%.
The Bank of England on Thursday matched the U.S. Federal Reserve by hiking interest rates by a quarter percentage point.
The 7-2 decision, the eleventh consecutive increase, brings the U.K. base rate to 4.25%, and comes after data showed inflation surprisingly accelerated in February to a year-over-year rate of 10.4%.
“Headline CPI inflation had surprised significantly on the upside and the near-term path of GDP was likely to be somewhat stronger than expected previously,” the Bank of England said in the simultaneously published minutes of the meeting. “The members put some weight on the possibility that the stronger domestic and global outlook for demand was also being driven by factors over and above the weaker path of energy prices, given that the strengthening had at least in part preceded the falls in prices.”
“If there were to be evidence of more persistent pressures, then further tightening in monetary policy would be required,” the central bank said.
The central bank did discuss the banking sector, and the failure of the U.S.’s Silicon Valley Bank and the run-up to UBS’s UBS, -3.09%
purchase of Credit Suisse CS, -5.48%.
SVB’s U.K. subsidiary was bought by HSBC for £1.
The central bank’s financial policy committee said the U.K. banking system maintains robust capital and strong liquidity positions and can “continue supporting the economy” even as interest rates rise.
The pound GBPUSD, +0.45%
traded over $1.23 after the decision. The yield on the 2-year gilt TMBMKGB-02Y, 3.388%
however slipped 7 basis points to 3.42%, after a big rise on Wednesday when the inflation data came out.
Most Asia Pacific shares pared early losses on Thursday, after the US Federal Reserve reaffirmed its dedication to bring down inflation.
In Hong Kong, the benchmark Hang Seng
(HSI) index traded 1.5% higher, leading gainers in the region. One of the top gainers was internet giant Tencent, which was more than 7% higher after posting a strong rise in its online advertising business in the December quarter on Wednesday.
In Japan, the Nikkei 225
(N225) was flat after opening lower. The broader Topix index was 0.3% lower, reversing some of its early morning losses.
South Korea’s Kospi was 0.2% higher, while Australia’s S&P ASX 200 advanced by half a percentage point.
Asian shares had opened broadly lower, tracking losses on Wall Street. In the US, the Dow closed 1.6% lower, while the S&P 500
(DVS) slipped about 1.7%. The Nasdaq Composite declined 1.6%.
“Looking ahead, while we see fundamental value in Asia-ex Japan stocks … we remain concerned about a possible pullback in US stocks assuming US data deteriorates in the months ahead,” Nomura analysts wrote in a Thursday research note.
US markets had been fickle on Wednesday before settling in the red as investors digested the Federal Reserve’s quarter-point rate hike and looked for clues about the state of the banking sector meltdown.
The Fed raised rates by a quarter point at the conclusion of its two-day meeting, even though its historic rate hiking campaign was a contributing factor in the banking crisis.
Investors were heartened by the central bank’s strong hints that its aggressive pace of interest rate hikes would come to an end soon. Still, the central bank also warned that rate cuts aren’t coming this year.
– CNN’s Krystal Hur and Laura He contributed reporting
All eyes are trained on the Federal Reserve as it prepares to announce another potential interest rate hike Wednesday afternoon – exactly 10 days after the Biden administration stepped in with dramatic emergency actions to contain the fallout from two bank failures.
Biden White House officials will be closely watching the highly anticipated rate decision – and monitoring every word of Fed Chairman Jerome Powell’s public comments – for any telling clues on how the central bank is processing what has emerged one of the most urgent economic crises of Joe Biden’s presidency.
The moment creates a complex, if carefully observed, dynamic for the administration’s top economic officials who have spent much of the last two weeks engaged in regular discussions and consultations with Powell and Fed officials as they’ve navigated rapid and acute risks to the banking system.
The Fed’s central role in not only supervising US banks and the stability of the financial system, but also in serving as a liquidity backstop in moments of systemic risk, has once again thrust the central bank back to center stage in the government’s effort to stabilize rattled markets.
But Biden has made the central bank’s independence on monetary policy an unequivocal commitment – and has repeatedly underscored that he has confidence in the Fed’s central role in navigating inflation that has weighed on the US economy for more than a year and remained stubbornly persistent.
Even as some congressional Democrats have directed fire at Powell for the rapid increase in interest rates and the risks the effort poses to a robust post-pandemic economic recovery, White House officials have taken pains not to shed light on their views publicly.
Officials stress nothing in the last week has changed that mandate from Biden – and note that the widespread uncertainty about what action the Fed will take on rates only serves to underscore that reality.
It’s a reality that comes at a uniquely inopportune time for a banking system that has shown clear signs of stabilizing in the last several days, but is still facing a level of anxiety among market participants and depositors about the durability of that shift.
“I do believe we have a very strong and resilient banking system and all of us need to shore up the confidence of depositors that that’s the case,” Treasury Secretary Janet Yellen said during remarks Tuesday in Washington.
Yellen said a new emergency lending facility launched by the Fed, along with its existing discount window, are “working as intended to provide liquidity to the banking system.”
But prior to the closures of Silicon Valley Bank and Signature Bank, analysts had widely predicted that the Fed would unveil a half-point rate hike. But after the sudden collapse of the two banks that sent shockwaves across the global economy, there has been a growing belief among Wall Street analysts that the central bank will pull back, and only raise rates by a quarter-point – in part to try to alleviate concerns that the Fed’s historically aggressive rate hikes over the past year were precisely to blame for this month’s financial turmoil.
But there are also concerns that a dramatic pullback, like choosing to forgo any rate increases altogether until a later meeting, would bring its own risks of signaling to the market that there are deeper systemic problems.
It’s a conundrum top Fed officials started grappling with in the first of their two-day Federal Open Market Committee meeting on Tuesday. How they choose to navigate the path ahead will remain behind closed doors until their policy statement is released Wednesday afternoon.
Powell is scheduled to speak to reporters shortly after.
For officials inside the Biden White House, Wednesday is poised to offer critical insight into how the central bank is grappling with its urgent priority of bringing down inflation, while at the same time, minimizing the risk of additional dominoes falling in the US banking sector.
Those two imperatives – bringing prices down and maintaining stability across the US financial sector – are urgent priorities for the Biden White House, particularly as the president moves closer to a widely expected reelection announcement and the health of the economy remains the top issue for voters.
Yet the Fed’s decision will come at a moment of accelerating political pressure on the Fed itself – and Powell specifically.
Massachusetts Democratic Sen. Elizabeth Warren, a member of the Senate Banking Committee, slammed Powell, saying he has failed at two of his main jobs, citing raising interest rates and his support of bank deregulation.
“I opposed Chair Powell for his initial nomination, but his re-nomination. I opposed him because of his views on regulation and what he was doing to weaken regulation, but I think he’s failing in both jobs, both as oversight manager of these big banks which is his job and also what he’s doing with inflation,” Warren said on NBC’s “Meet the Press.”
White House officials have made clear – with no hesitation – that Biden’s long-stated confidence in Powell is unchanged. Powell, who was confirmed for his second four-year term as Fed chair last year, announced last week that the Fed would launch a review into the failure of Silicon Valley Bank.
Treasury and Fed officials, along with counterparts at other federal regulators and their international counterparts, have continued regular discussions this week as they’ve monitored the system in the wake of the weekend collapse, and eventual sale, of European banking giant Credit Suisse.
US officials viewed the Credit Suisse collapse as unrelated to the crisis that took down the US banks a weekend prior, although they acknowledged it posed broader risks tied to confidence, or the potential lack thereof, in the system.
In recent days, White House officials have begun to cautiously suggest that they see signs of the US economy stabilizing, following the turbulent aftermath of the closures of Silicon Valley Bank and Signature Bank. Biden, for his part, has credited the sweeping steps his administration announced – namely, the backstopping of all depositors’ funds held at the two institutions and the creation of an emergency lending program by the Federal Reserve – as having prevented a broader financial meltdown.
He has also called on US regulators and lawmakers to strengthen financial regulations, though it is not yet clear what specific actions the president may ultimately throw his weight behind.
Press secretary Karine Jean-Pierre declined to comment Tuesday afternoon at the White House press briefing on how she and other officials were watching the Fed’s upcoming decision.
“The Fed is indeed independent. We want to give them the space to make those monetary decisions and I don’t want to get ahead of that,” Jean-Pierre said. “I don’t even want to give any thoughts to what Jerome Powell might say tomorrow.”
Stocks in the Asia Pacific region rose Tuesday as concerns about the global banking sector eased in response to a whirlwind of intervention by policymakers and industry players.
The S&P/ASX 200 in Australia jumped 1.3%, boosted by its AXFJ index, a measure of banking stocks, which surged 1.7%.
In Hong Kong, the Hang Seng Index
(HSI) opened up 0.8%. China’s Shanghai Composite was 0.3% higher at the start of its trading session.
South Korea’s Kospi ticked up 0.8%. Japanese markets were closed for a public holiday. Singapore’s Straits Times Index gained 1.1%.
US stock futures were flat in Asian trade Tuesday, with Dow futures, S&P 500 futures and Nasdaq futures little changed.
That followed a sunnier day on Wall Street, as investors became more confident in the outlook for the general banking sector, sending shares up.
On Monday, central banks across Asia Pacific moved to quell concerns about the finance industry, with authorities in Australia, Hong Kong, Singapore and the Philippines assuring the public that their money was safe following the emergency bailout of Credit Suisse over the weekend.
That did little to stop stocks from slumping initially, though analysts had predicted global markets could see calm later on Monday as investor nerves settled and relief set in. The landmark rescue of Credit Suisse
(CS) by bigger Swiss rival UBS
(UBS) on Sunday was followed by a coordinated move by major central banks to boost the flow of US dollars through financial markets.
Shares of UBS rose about 3.3% in an intraday reversal on Monday, following a drop of as much as 15% earlier in the session.
Still, recession fears continue to dog investors ahead of the US Federal Reserve’s meeting, which is set to conclude Wednesday. Traders see about a 73% probability of the central bank raising interest rates by 25 basis points.
US regional banks also aren’t out of the woods yet. Shares of First Republic
(FRC), the struggling California bank bailed out by a consortium of banks last week, fell to an intraday record low Monday before ending the session down about 47% in another day of steep losses for the company.
The Dow
(INDU) closed 1.2% higher, while the S&P 500
(SPX) gained about 0.9%. The Nasdaq Composite
(COMP) climbed 0.4%.
The Federal Reserve will meet on Wednesday and, for once, the outcome is unclear.
This is the most uncertain Fed meeting since 2008, said Jim Bianco, president of Bianco Research.
Fed officials, starting with former chair Ben Bernanke, have perfected the art of having the market price in what the central bank will do — at least regarding interest rates — at each upcoming meeting. That has happened 100% of the time, Bianco said on Twitter.
The Fed’s meeting this week is different because it follows the sudden collapse of confidence in the U.S. banking system following the government takeover of Silicon Valley Bank as well as the tremors around the world that have led to the shotgun wedding of Swiss banking giant Credit Suisse and its longtime rival, UBS.
At the moment, the market probabilities are 73% for a quarter-percentage-point move and 27% for no move, according to the CME FedWatch tool. The market seems to be growing in confidence of a hike, analysts said, based on movements on the front end of the curve.
“Depending on your perspective, the Fed’s decision will be seen as either capitulation to the markets or ivory-tower isolation from the markets,” said Ian Katz, a financial sector analyst with Capital Alpha Partners.
Here are the pros and cons for both a pause and a 25-basis-point hike.
The case for and against a pause
The main rationale for a pause is that the banking system is under stress.
“While policymakers have responded aggressively to shore up the financial system, markets appear to be less than fully convinced that efforts to support small and midsize banks will prove sufficient. We think Fed officials will therefore share our view that stress in the banking system remains the most immediate concern for now,” said Jan Hatzius, chief economist at Goldman Sachs, in a note to clients Monday morning.
Former New York Fed President William Dudley said he would recommend a pause. “The case for zero is ‘do no harm,’” he said.
The case against a pause is that it could spark more worries about the banking system.
“I think if they pause, they are going to have to explain exactly what they are seeing, what is giving them more concern. I am not sure a pause is comforting,” said former Fed Vice Chair Roger Ferguson in a television interview on Monday
The case for and against a 25-basis-point hike
The main reason for a quarter-percentage-point rate increase, to a range of 4.75%-5%, is that it could project confidence.
“What you need from policymakers is steady hands, steady ship,” said Max Kettner, chief multi-asset strategist at HSBC. “You don’t need overaction … flip-flopping around in projections or opinions.”
The Fed should say that it has managed to contain confidence so far and that “we can press ahead with the inflation fight,” he added.
Oren Klachkin, lead U.S. economist at Oxford Economics, said he didn’t think “the recent bank failures pose systemic risks to the broad financial system and economy.”
He noted that “inflation is still running hot” and the Fed has better ways to alleviate banking-sector stress than interest rates.
The case against hiking is that doing so could further exacerbate concerns about the stability of the banking sector.
“A rate hike now might have to be quickly reversed to deal with a deeper, less contained recession and disinflation. Why would the Fed raise rates when it may be forced to cut rates so much sooner than previously hoped?” asked Diane Swonk, chief economist at KPMG.
Gregory Daco, chief economist at EY, said he thinks economic activity is slowing, which gives the Fed time.
“There is no rush to hike. We are not going to see hyperinflation as a result,” he said.
SPX, +0.89%
rose Monday. The yield on the 10-year Treasury note TMUBMUSD10Y, 3.485%
inched up to 3.46%, still well below the 4% level seen prior to the banking crisis.
