By: Dave Chenet, CFA, CAIA®
|Close||Weekly return||YTD return|
|US Treasury 10yr Yield||3.395%|
Source: YCharts, Yahoo! Finance, WSJ
Major US stock indices finished the week higher amidst volatility driven by continued pressure in the banking sector as both the government and other large banking institutions took action in attempt to provide liquidity to smaller banks facing large outflows and also to shore up confidence in the banking sector as a whole. In a “flight to quality” trade, investors pushed higher the prices of US treasury bonds and gold this week.
Investors will be very focused on the Federal Reserve next week to see if the stress in the banking sector will be enough to convince the Fed to pause its rate-hiking cycle. The Fed knows that fiscal policy impacts the economy on a lag and that its aggressive tightening contributed to the troubles experienced by SVB and others (albeit, poor management and other mistakes certainly were also contributing factors). The Fed must, however, balance these risks with the risk of giving up ground in its fight against inflation. Market expectations on the path of the Fed have changed drastically, with the market now expecting the Fed to begin cutting short-term rates by the end of the year.
Our analysis of the data suggests that inflation will continue to moderate as the fiscal tightening continues to depress consumer spending and excessive credit creation. However, we do not believe that inflation will fall back below 2% in the short-term as short-term rates are still below the level of inflation and the provision of liquidity to the banking sector increases money supply. While the Fed is very likely close to the end of their hiking cycle, the market may be too sanguine to expect outright rate cuts by year-end. As such, we continue to have conviction that investors will be well-served by reducing their exposure to non-profitable speculative stocks and seeking the stability of companies with high quality balance sheets, stocks that pay dividends and high quality bonds. This turmoil will eventually dissipate, but in the meantime, a focus on quality and safety is prudent.
What We’re Reading:
WSJ: Tech Stocks Seem to Be a Haven From the Banking Crisis, for Now
CNBC: Long-awaited Fed digital payment system to launch in July
Moody’s Analytics: Going Down the Debt Limit Rabbit Hole
Chart of the Week:
With the talk around the Fed’s action around increasing the short-term Federal Funds Rate, there has been very little talk about the reducing in the size of the Fed’s balance sheet, which ballooned to just under $9T by mid-2022. Since then, the Fed has been engaged in a monthly reduction in balance sheet assets, or “Quantitative Tightening (QT).” QT reversed last week, with the ~$300b in liquidity provided to banks reversing almost 6-months of tightening.