Future investment strategy
Markets went on a roller coaster ride in March given ongoing concerns regarding banks in the US and Europe. The high-profile failures of Silicon Valley Bank and Signature Bank followed by the crises of confidence in Credit Suisse has put the banking sector under much scrutiny. Fortunately, response from policymakers and regulators to stem contagion was swift and comprehensive. The US government announced a new facility – the Bank Term Funding Program (BTFP) – which allows banks to borrow from the Fed using their bond portfolios valued at par as collateral, eliminating the need to sell assets at a loss to fund withdrawals. Federal regulators also announced that depositors of the failed banks would be paid in full. Meanwhile the Swiss National Bank shored up confidence and served as matchmaker to a shotgun wedding between UBS and Credit Suisse.
While this addressed the problem of contagion created by the crisis and helped contain risks to the financial system as a whole, the debacle has highlighted risks of rapid deposit outflows and potential problems meeting these given the degree of unrealized losses on bond holdings. Investors were also reminded how important confidence is in the financial sector and how vulnerable institutions can be once customer confidence is lost. The MSCI World Financials Index fell by -7.70%.
The full implications for global growth and markets are still being digested. Whether or not stresses will reemerge remains a concern. Further, problems in the banking sector have caused a reassessment of how much more monetary tightening is possible. Still, the FOMC decided to hike rates by 25bps in their March meeting, though it was admittedly a dovish rate hike with guidance around future rate hikes changed. Language referring to “ongoing increases” was removed. Clearly, the Fed has a difficult balancing act ahead of them: with price stability on the one side and financial stability on the other.
That said, we have gotten some signs that US inflation is cooling which could well give the Fed some breathing room. February core PCE price index came in below consensus expectations at 0.30% m/m. US PCE core services ex-housing was only up +0.27%. This is important because this is the category of inflation that Chair Powell is most concerned about. More optimism on inflation rolling over came from personal income growing at a slower than expected pace, as well as softer discretionary spending.
Europe’s inflation is decidedly more challenging. Eurozone HICP fell sharply, but core inflation is still rising. In turn, the ECB hiked rates by 50bps and raised its forecasts for inflation in 2023. The ECB’s decision shows that it remains focused on controlling inflation as its top priority. Some market participants may have viewed the ECB’s decision as a show of confidence, signaling there is no crisis and it is ‘business as usual’ for European banks. European economic activity again proved to be more resilient than anticipated, driven by a stronger service sector.
As a result of the turmoil, treasury yields fell sharply with the 2-year falling below 4% from a high of 5.07%, driven by the view that the Fed will be cutting rates, despite what Chair Powell has said. Fed funds futures are starting to suggest Fed has reached end of tightening cycle. The fall in yields led to a rally in growth stocks, with the Nasdaq returning +9.54%. Gold outperformed as a safe haven asset, but the traditional drivers of lower USD and lower real rates also played their part.