Market Commentary: Week of March 13, 2023

Last Week

Last week started with Chairman Powell on the Hill where he testified Tuesday and Wednesday, stating that, given the recent economic data, perhaps the pace of the Fed’s policy tightening would have to quicken. This was interpreted as a 50-basis point hike was very possible at the March 22-23 FOMC meeting and treasury yields sprung higher with the 2-year note getting as high as 5.07% on Tuesday while the 10-year touched 4%.

Then, on Thursday, with the markets on edge for the February employment report due the next morning, we all learned that there was a bank out in California called Silicon Valley Bank (SVB)!

SVB’s customer base was extremely concentrated in the tech sector. It appears that every tech start-up in Silicon Valley did ALL their banking with SVB as apparently, the 27-year-old CEOs missed their lesson on risk management, particularly the risk of putting all of their company’s money into one bank where only $250,000 was FDIC insured. They also didn’t account for the fact that the company’s “unique profile” was actually a carbon copy of the other many hundred startups that also did all their banking at SVB.

Things were great for SVB in the time of COVID-19 when, due to the Fed’s zero rate interest rate policy (ZIRP), billions flowed into their coffers in the form of zero interest rate deposits. SVB turned around and bought Treasury Notes, Callable Agency notes, and Freddie, Fannie, and Ginnie Mae MBS with these deposits. This set up a horrific balance sheet duration mismatch should the Fed be forced to raise rates at a breakneck pace, which is exactly what has happened.

Stocks and corporate credit sold off hard Thursday and Friday, with bank stocks getting pummeled.

• The S&P 500 plunged 4.52%% for the week. The average daily move was 1.01%.
• The NASDAQ also plunged, dropping 4.71% for the week. The average daily move for the week was 1.11%.
• The 2-year Treasury yield started the week increasing 21 basis points, breaching 5% on Wednesday only to crash an eyepopping 49 basis points, closing at 4.59% on Friday. Thursday the 2-year hit a new year-over-year high of 4.89%. High year-over-year 5.07%, low yield 1.85%.
• The 10-year Treasury yield dropped 25 basis points for the week, closing at 3.70% on Friday. Year-over-year high yield 4.24%, low yield 2.135%.
• The VIX Index surged 34% for the week, closing at 24.80 Friday. Year-over-year high 36.45 and low 17.87.
• The MOVE Index jumped 14.33% for the week, closing at 140.06 on Friday. Year-over-year high 160.72 and low 91.76.
• 5-year Investment Grade Corporates (as measured by Markit CDX) spreads widened 13 basis points for the week closing at 84 basis points Friday. High spread Year-over-year high of 111 and low of 64.
• High Yield corporate debt (as measured by Markit CDX) spreads blew out 65 basis points, closing at 498 basis points on Friday. Year-over-year high 627, and low 355.
• U.S. Dollar Index ended the week nearly unchanged closing at 104.58 on Friday. Year-over-year high 114.11 and low 97.79.
• WTI Crude declined 3.77% for the week, using the April 2023 WTI Futures contract, closing at 76.68 Friday. Year-over-year high 123.70, and low 71.02.
• Gold, as measured by the April futures contract, rose 0.76% for the week closing at 1,867 on Friday. The high price for the front contract year-over-year is 2,043 and the low is 1,623.
• Bitcoin dropped 9.62% for the week closing at 20.102 on Friday. High price year-over-year 47,967 and low 15,632.

The Week Ahead

We come in this morning down about 50 basis points in yield, while the 10-year is down by about 25 basis points. Equity futures are off approximately 1.5%. It was often said that the Fed was going to keep raising until something breaks and now, something broke!

One economist described the latest Fed action: "The Fed is putting out a fire that they set.” With that, we are back to new acronyms from the Fed. The Fed rolled out a new facility for liquidity called the Bank Term Funding Program (BTFP) to halt bank runs or at least provide instant liquidity for banks should there be runs. The term is one year and banks and credit unions can tap the program with collateral, including Treasury notes, Agency notes, and mortgage-backed securities, all with zero haircuts (par). The Fed also announced that the discount window “remains open and available," with the same collateral under the BTFP allowable with no haircut.

With this, the Fed has completely back-stopped liquidity for the banking sector, which hopefully will stem any more bank runs. While the danger of bank and credit union runs is probably off the table, or the risk of them off the table (people may run to the bank but the bank can tap the BTFP if they need liquidity) the problem of about $600 billion of low coupon bonds sitting on banks books underwater is a huge problem.

I’ve heard some wave off this risk because “the bank doesn’t have to mark them to market.” To that I say, firstly, about $300 billion of those underwater bonds are classified as “Available for Sale." That means, while those mark-to-market losses are not run through earnings, they do hit the balance sheet as a capital reduction.

Secondly, unless the Fed starts cutting rates aggressively and bank funding rates follow, banks are left funding assets yielding less than 2% with a decent chunk of liabilities yielding over 4%. That isn’t a great outlook. Maybe the only silver lining is a nice banking crisis will solve the Fed’s inflation problem!

Definitions:

An index is unmanaged and not available for direct investment. Definitions sourced from Bloomberg. The Bloomberg Barclays Global Aggregate Negative Yielding Debt Market Value Index represents the portion of the Bloomberg Barclays Global Aggregate Index that measures the aggregate value of global debt with a negative yield.• The S&P 500® is widely regarded as the best single gauge of large-cap U.S. equities and serves as the foundation for a wide range of investment products. The index includes 500 leading companies and captures approximately 80% coverage of available market capitalization.• The NASDAQ Composite Index is a broad-based capitalization-weighted index of stocks in all three NASDAQ tiers: Global Select, Global Market and Capital Market. The index was developed with a base level of 100 as of February 5, 1971.• The Cboe Volatility Index® (VIX) is a calculation designed to produce a measure of constant, 30-day expected volatility of the US stock market, derived from real-time, mid-quote prices of weekly S&P 500® Index (SPX) call and put options with range of 23 to 37 days to expiration.• The ICE BofA MOVE Index is a yield curve-weighted index of the normalized implied volatility on 1-month Treasury options. It is the weighted average of implied volatilities on the CT2 (Current 2 Year Government Note), CT5 (Current 5 Year Government Note), CT10 (Current 10 Year Government Note), and CT30 (Current 30 Year Government Note), with weights 0.2/0.2/0.4/0.2 respectively.• The Markit CDX North America Investment Grade Index is composed of 125 equally weighted credit default swaps on investment grade entities, distributed among 6 sub-indices: High Volatility, Consumer, Energy, Financial, Industrial, Technology, Media & Telecommunications. Markit CDX indices roll every 6 months in March & September.• The Markit CDX North America High Yield Index is composed of 100 non-investment grade entities, distributed among 2 sub-indices: B, BB. All entities are domiciled in North America. Markit CDX indices roll every 6 months in March & September.• The U.S. Dollar Index (USDX) indicates the general international value of the USD. The USDX does this by averaging the exchange rates between the USD and major world currencies. Intercontinental Exchange (ICE) US computes this by using the rates supplied by some 500 banks.

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