Keep Calm and Carry On

Scott Anderson
Chief Economist
Bank of the West

Regional bank stocks remained under heavy selling pressure this past week in the wake of the FOMC’s quarter point rate hike on Wednesday, but it could have been worse for financial market conditions overall. The Fed balance sheet data released yesterday for the past week, shows total bank borrowing from the Federal Reserve, both Discount Window borrowing and Bank Term Funding Program (BTFP) borrowing, totaled $163.9 billion last week down about a billion from the week before at $164.8 billion. Discount Window borrowing dropped to $110.2 billion from $152.9 billion the week before, while BTFP borrowing increased to $53.7 from $11.9 billion. The good news here is that bank liquidity does not appear to have materially worsened since the first week, and showed some encouraging signs of stability.

As of this writing, the major U.S. stock market indexes managed to rise this week despite volatile daily sessions. Over the past five days the Dow was up 0.67%, the S&P 500 was up 0.46%, and the NASDAQ climbed 0.85%. Looking at the VIX, a market measure of expected S&P 500 stock market volatility, U.S. equity prices are expected to remain relatively tame near-term, at least by historical standards. The CBOE VIX was trading around 24.1 on Friday just about spot-on with the historical trend line.

Stock Investors Appear To Be Rotating Not Divesting
While Jerome Powell and the FOMC highlighted the risk of tighter bank credit having an uncertain future negative impact on economic activity, hiring, and inflation, the Goldman Sachs Financial Conditions Index has only modestly tightened in recent weeks and remains far lower than in October of 2022, the start of the pandemic, or during the Great Recession.

Financial Conditions Remain Relatively Sanguine
More signs of relative financial calm can be found in the corporate bond market. High yield and other corporate bond spreads over the 10-year Treasury yield have risen in recent weeks, but remain quite low by historical standards. This means bond investors are not super concerned about future credit losses or credit risk in a broad cross section of industries, or even in some of the most risky credits and companies. If recession were imminent as the Fed funds futures market and Treasury yield curve appear to be communicating, one would expect to see these corporate bond spreads more fully pricing in the financial and default risks ahead. Instead, there appears to be a pretty substantial disconnect across financial metrics that often herald the onset of recession.

Corporate Spreads Show Little Fear of Credit Losses
Fed funds futures are currently projecting no additional Fed rate hike in May and 100 basis points of Fed rate cuts before the end of the year.

Will The Fed’s Next Move Be A Rate Cut Or Another Hike?
This is a dramatic repricing of Fed funds rate hike expectations and caused tremendous volatility in the Treasury bond market. The Merrill Lynch Option Volatility Index or MOVE Index, which measures the implied volatility in the Treasury bond market, jumped to the highest levels since the Great Recession and remains very elevated this week.

Turmoil in the Treasury Market
So far for March, the initial jobless claims data and S&P Global PMI indexes indicate U.S. economic and employment growth is still continuing at a decent pace. Unless we get a significant worsening of economic and financial conditions in April, another Fed rate hike in May still appears more likely than not in our opinion, and the prospect of rate cuts this year remains fairly remote. Failure to raise the Federal debt ceiling in a timely manner and with no delay is the biggest downside risk to our economic and interest rate forecasts today.

To learn more, check out this week's U.S. Outlook Report.


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