The equity markets zig-zagged last week as investors digested the latest news on the failures of the Silicon Valley Bank, Signature Bank, and later Credit Suisse, with First Republic Bank receiving emergency intervention last week by 11 of the world’s largest banks. Financial stability overtook inflation as a critical concern, followed by the Fed’s ability to prevent contagion to other regional banks. The Fed, Treasury and FDIC responded by backstopping all depositors of both failed banks, including deposits over the $250,000 limit. In addition, the Fed will provide a lending program to provide liquidity by accepting as collateral securities at face value rather than the market. The impact of the banking sector on slowing economic activity propelled hopes that the Federal Reserve would reduce the pace of rate increases or even pause at the next meeting of the FOMC scheduled for March 21 and 22. Until a week ago, the debate around the next rate increase centered around whether the Fed would raise rates by 25 basis points or 50.
The equity sector performance last week ranged from solid gains in communication services and mega technology shares with significant free cash flow and no exposure to regional banks to significant losses in financial services and energy shares. Oil lost over 13% in the week, dragging down the TSX despite the Canadian banks holding up relatively well compared to their US counterparts. Bonds posted a strong performance in the week as investors ran to the safety of Treasuries. European equities tumbled on worries about the financial system and a 50-basis point hike in the deposit rate by the European Central Banks. The ECB’s latest increase raised the deposit rate to 3% in their fight against inflation. However, it provided no forward guidance but stated that future rate increases would be data dependent. The French CAC 40 Index lost 4.09%, Germany’s DAX fell 4.28%, Italy’s FTSE MIB dropped 6.55%, and the UK’s FTSE 100 Index declined 5.33% in the week.
The latest CPI data released by the US Bureau of Labor Statistics on Tuesday reported that CPI for all items rose by 0.4% in February after increasing by 0.5% in January, bringing the 12-month increase to 6%. In addition, the Core CPI (excluding food and energy) rose by 0.5% in February after increasing by 0.4% in January and 5.5% over the last twelve months. Shelter accounted for over 70% of the month’s increase; food increased by 0.4%, and energy decreased by 0.6% as natural gas and fuel oil indexes declined.1 Unfortunately, the Fed keeps close tabs on the core inflation rate as a better indicator of future inflation trends.
On Wednesday, the US Census Bureau reported that sales at retailers and food services for February declined 0.4% from January. The latest decline is the third decline in four months, indicating that higher interest rates could contribute to slowing consumer spending and economic growth.2 Also, on Wednesday, the Bureau of Labor Statistics reported that the Producer Price Index for final demand declined by 0.1% in February, the second decline in three months. Stripping out food and energy costs, the index for final demand rose 0.2%. Although still substantially higher than a year ago, food declined for the third consecutive month.3
The New York Federal Reserve reported business activity in New York State declined 19 points to a negative 24.6. The new orders index declined significantly while shipments declined slightly. Unfilled orders dropped 6.7 points, another sign of slowing economic conditions.4
On Thursday, initial employment jobless claims for the week ending March 11 decreased by 20,000 to 192,000. A number below 200,000 is considered an indication that layoffs remain low despite the strain on the economy. Claims for benefits from all programs for the week ending February 25 increased by 79,630 to 2,000,239.5 Also, on Thursday, the government reported construction on new homes jumped 9.8% in February, and building permits surged by 13.8%. The big jump in single-family home construction occurred in the west, with the mid-west and the southern regions reporting an easing in permitting.6
On Friday, the Conference Board reported the Leading Economic Index or LEI. The LEI comprises ten indicators designed to show whether the economy is improving or deteriorating. The index fell 0.3% in February for the eleventh consecutive decline. The LEI is signaling a recession and has for several months. Eight of the ten indicators declined in February.7 And finally, on Friday, the Michigan Consumer Sentiment Survey, taken in part before the collapse of SVB and Signature Bank, fell in February to 63.4 from 67.0. The Current Economic Conditions Survey declined to 66.4 from 70.7, and the Index of Consumer Expectations declined to 61.5 from 64.7. Worthy of note is the consumer inflation expectations declined for the year ahead to 3.8% from 4.1%, and the long-run inflation expectations drifted lower to 2.8%, falling below the 2.9% – 3.1% range for only the second time in 20 months.8
The unintended consequence of the rapid rate increases of the Central Banks’ monetary policies is putting stress on the banking system, which we think is ripe for consolidation in the US. Until the bifurcation of the US banking system is dealt with, the uncertainty may create more volatility in the coming weeks and months ahead. We believe distortions will appear in sectors only to be later unwound.
Sources:
1 https://www.bls.gov/news.release/cpi.nr0.htm
2 https://www.census.gov/retail/marts/www/marts_current.pdf
3 https://www.bls.gov/news.release/ppi.nr0.htm
4 https://www.newyorkfed.org/medialibrary/media/survey/empire/empire2023/esms_2023_03.pdf?la=en
5 https://www.dol.gov/ui/data.pdf
6 https://www.census.gov/economic-indicators/
7 https://www.conference-board.org/topics/us-leading-indicators
8 http://www.sca.isr.umich.edu/
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Warren Gerow is an independent investment wealth consultant to Sightline Wealth Management.
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