Futures markets suggest a negative open to today’s stock trading. As investors try to gauge near-term prospects for interest rates, the banking industry, and the economy, U.S. stock indexes may have trouble securing gains this week. February durable goods orders data was released pre-trading, and showed a modest contraction of 0.1%, somewhat better than economists’ expectations and not as great as the revised 5.0% decline posted in the first month of 2023. Shortly, St. Louis Federal Reserve President James Bullard will present his view on the economy and central bank policy, followed by S&P Global Purchasing Managers Index readings on the services and manufacturing sectors for the current month. The services index could well show a continued slight expansion, while the manufacturing index will probably indicate a further slowing of activity. In the face of ongoing volatility, the NASDAQ has held firmer than the Standard & Poor’s 500 and the Dow Jones Industrial Average.
Most visibly, this past Wednesday, Chairman Jerome Powell announced the Fed’s decision to raise short-term interest rates by another one-quarter of a percentage point, to 4.75%-5.00%, generally what Wall Street had been expecting just prior to the central bank’s two-day meeting. Mr. Powell suggested that an additional one-quarter hike in rates may be appropriate in May. Notwithstanding recent turmoil in the financial sector, highlighted by the failures of California bank SVB Financial Group (SIVB) and New-York-based Signature Bank (SBNY), the Fed is concerned that the economy remains healthy enough to keep wages and price inflation on stronger upward tracks than it would like. Stocks have moved on the conjectures of Mr. Powell, other Fed officials, and the Treasury Department.
In recent weeks, the Federal Deposit Insurance Corp. (FDIC) seized SVB Financial and Signature Bank, assuring all depositors that they would be made whole. Investors are worried that other regional banks could run into trouble, especially those in California, most prominently First Republic Bank (FRC). Government and industry leaders appear to be in favor of larger institutions buying the assets of some of the ailing regionals. Note that, on the European front, UBS Group (UBS) has agreed to purchase Credit Suisse Group (CS). U.S. Treasury Secretary Janet Yellen has said that the FDIC would continue to cover bank deposits of up to $250,000. It would take an act of Congress to allow that agency to back deposits at a higher level or entirely. Many U.S. representatives are, indeed, discussing such action, which is by no means guaranteed.
Uncertainty in the financial sector will persist in the days, weeks, and months ahead. Rising interest rates have had the effect of reducing the prices of fixed-income securities held on bank balance sheets. (Expectations of a pause in rate hikes and possible cuts later this year have brought a modicum of relief to bond valuations in recent days.) Bank customers have been shifting deposits to higher-paying money-market accounts and other like cash instruments. The reduced access to low-cost funding for loan origination is hurting the profitability of banks. Too, bank managers are becoming more conservative about lending, as they work to bolster their companies’ capital positions, via stock issues or “white knight” peer cash infusions. There also is a good deal of financial institution exposure to the commercial real estate loan and mortgage backed securities segments. Sizable loans are coming due and will need to be refinanced at significantly higher rates. It looks as if the economy faces meaningful stress through the end of this year and into 2024.
Mr. Powell and Ms. Yellen believe that the failures of SVB and Signature are unusual “one-off” events, and that the financial sector is sound. Even so, it’s probably best investors sustain a defensive posture. Currently, aside from holding cash and gold, investors have viewed large-cap tech issues, such as Alphabet (GOOG), Apple (AAPL), Amazon.com (AMZN), and Microsoft (MSFT), as a safe harbor, which seems quite prudent, at least in the short run. – David M. Reimer
At the time of this article’s writing, the author did not hold any positions in any of the companies mentioned.
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