Key Points:
- Concerns in the banking industry developed in March after the collapse of Silicon Valley and Signature Banks.
- The stock market was resilient, with the S&P500 gaining 3.67% despite Fed hiking interest rates an additional 25 basis points.
- High quality bonds gained during the month as yields fell. Lower rated debt lagged as credit spreads widened on the prospect of worsening financial conditions.
After a dramatic rise in Treasury yields over the past 12 months from the Fed trying to rein in inflation, the banking sector was rattled with the failures of Silicon Valley and Signature Banks. These collapses appear to be contained and do not seem to be part of a larger systemic issue in the financial system. The Federal reserve stepped in to provide liquidity to all banks in an effort to calm depositors. However, financial conditions are sure to tighten as liquidity becomes top priority to ensure that depositors are confident in the solvency of their banks. Higher lending standards should raise borrowing costs for smaller and unprofitable companies. This may help the Fed’s cause in reducing inflation from slower demand, but it also increases the likelihood, and perhaps magnitude, of an economic recession in the next few quarters. Banking sector issues could cause businesses in all industries to pause hiring and business investment.
Stocks were mixed during March as the selloff in financials (-9.6%) was offset by the run-up in technology (+10.9%) and telecom (+10.4%) stocks. Utilities (+4.92%) and consumer staples (+4.23%) also gained as investors favored defensive equities. Small cap stocks, which have a higher percentage of regional banks than large caps, fell 4.8% as measured by the Russell 2000. The S&P 500 gained 3.67%, while the NASDAQ Composite was up 9.5%, benefitting from lower financials weight and declining Treasury yields. Both international developed and emerging market stocks moved higher during March, despite additional banking issues abroad. UBS bought Credit Suisse to avoid continued stress and uncertainty to the global financial system.
Treasury yields fell in March as investors sought the safety in high quality bonds. This drop in yields should help bank’s asset-liability mismatch, but the yield curve is still inverted which makes lending difficult. While yields fell, the Fed raised their benchmark Fed Funds rate an additional 25 basis points, displaying their confidence in the system. Overall, bonds traded higher in March with the Bloomberg US Aggregate Bond Index up 2.54%. High yield bonds (lower credit quality) lagged the investment grade markets as credit spreads widened to reflect the additional risk. Moving forward the Fed will likely be more data dependent in their decisions to raise interest rates further to bring down inflation, but the recent banking issues may slow the economy more than previously forecasted.
Sources: Morningstar Direct, Wall Street Journal, JPMorgan