Friday, March 17, 2023
U.S. and International Equities
Stocks ended the week mixed as trading was quite volatile. Bank balance sheets are a new worry for investors, in addition to concerns with hawkish central banks’ tenuous response to persistent inflation. SVB Financial and Signature Bank’s failures this past weekend along with First Republic Bank’s challenges has market participants concerned over more banking woes as some investors believe the economy may be on the brink of recession.
As the Federal Reserve has increased interest rates, longer-term bonds purchased by banks have since declined in value, creating a headwind for the banking sector. Given the market decline of bonds last year, some poorly hedged banks find themselves in a predicament where they may need to raise additional capital per banking regulations. Raising capital may include stock sales, putting downward pressure on share prices as banks are hamstrung from the inverted yield curve.
Fixed Income Finished Mixed
The Bloomberg Aggregate Bond Index finished the week higher as yields declined, reversing a pattern of lower bond prices and higher yields. Given the concerns over the banking landscape, bond investors believe the Fed could reverse course on monetary policy and the “higher-for-longer” theme. In addition, high-yield corporate bonds, as tracked by the Bloomberg High Yield index, lost ground this week as this area was affected given the most recent bank failures. Last week, high yield was leading most fixed income areas year-to-date despite economic growth concerns. As of this week, they are now lagging core bonds.
U.S. corporate credit spreads widened last week with the investment grade segment higher by 0.15% and the high yield segment wider by 0.54%. Neither market has meaningful exposure to regional banks, so the selloff we’re seeing is likely from growing risk aversion instead of an increase in default expectations. Nonetheless, despite the recent widening, credit spreads for both markets are at historical average levels. We think the risk-reward is best in core bonds and in short-maturity investment grade corporate debt.
Energy prices finished lower as traders grew concerned over the present banking climate and its potential effect on the economy as oil reached a 15-month low this week. Natural gas prices declined even as winter makes a last stand in the United States. The major metals, gold, silver, and copper, ended the week mixed as gold and silver caught bids this week as some investors sought refuge in precious metals given this week’s banking news.
Economic Weekly Roundup
The monthly inflation rate slowed slightly to 0.4% in February from 0.5% the previous month, enough to push the annual rate of inflation down to the lowest since mid-2021. Housing costs accounted for over 70% of the increase in February and was the largest contributor to the monthly growth rate. This component will not likely be a significant driver of inflation by year-end as more multi-family units come to market. Headline annual inflation rose 6%, the smallest increase since September 2021 and should reassure investors that inflation will cool further in the coming months.
February Wholesale Prices
February producer prices posted an unexpected decline, providing positive news on price pressures amid next week’s Federal Reserve FOMC meeting. Wholesale prices declined 0.1% month-over-month as economists surveyed by FactSet predicted a 0.35% increase. This is compared to a 0.3% gain in January. On a 12-month basis, the index increased 4.6%.
Core wholesale prices, excluding food, energy, and trade, increased 0.2%, which was down from the 0.5% gain in January. On an annual basis, producer prices were up 4.4%, the same annual growth rate as January.
Used Car Prices Witness an Unexpected Price Jump
Manheim Used Vehicle Value Index, which tracks wholesale used-car prices at dealer auctions, rose 3.7% month-over-month in February. In addition, Manheim notes that February’s increase represents the largest growth for the month on record since the 4.4% rise in February 2009. Although prices were down 7% from a year earlier, they are now trending back toward record levels last reached in January 2022.
Manheim also reports that this increase is not typical for this particular time of the year. Dealer inventory has been light, but improving. However, the nation’s aging fleet has turned over at a relatively slow rate. S&P Global Mobility along with Kelly Blue Book state that the average automobile age presently on the road reached an all-time high of over 12 years in May 2022.
As inflation shows signs of receding, there are still some pockets of the economy where price pressures are sticky. This week’s used car report caused many economists to raise inflation estimates for February. We still believe that overall trend for inflation will decline, however areas like air transportation are still showing marginal signs of price improvement. The dynamics of the automobile market will be closely watched as consumer will eventually be forced to replace older vehicles.
February Retail Sales
Consumers pulled back on spending in February after a better-than-expected January. Total retail sales in February declined 0.4% month-over-month, which missed economists polled by FactSet estimates by 0.35%. Consumers spent less at restaurants, auto dealerships, furniture and home stores and department stores, and more on necessities like groceries. Excluding spending on autos, retail sales declined 0.1% in February. The trajectory of consumer spending weakened in February and now with volatile short term borrowing costs, the economy may soon tip into recession. Although our base case has the Fed hiking rates next week, the turmoil in short-term dollar borrowing may force the Fed to pause. Investors should focus on short-term funding markets for any hint of contagion.
Weekly Unemployment Report
Initial and continuing claims for the latest week came in below economists’ expectations as well as the prior weeks’ report. Labor markets continue to show limited signs of softening amid increasing layoffs.
The following economic data are slated for the week ahead:
- Tuesday: Existing home sales (Feb)
- Wednesday: FOMC meeting
- Thursday: Weekly initial and continuing unemployment claims, building permits (Feb), current accounts (Q4), new home sales (Feb)
- Friday: Durable orders (Feb), PMI composite (Mar), S&P Global PMI Manufacturing and Services (Mar)
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