WEEK AHEAD

The market pandemonium from the Silicon Valley Bank and now First Republic bailout has slammed the banking sector, raising pundits’ conjecture of a recession. Although the S&P 500 index returned +1.47% during the week, the Financial Sector as a whole returned -5.11%, sending the MTD return to -12.17%. A flight to safety conduct sent the bond market up +1.42%, notwithstanding a highly anticipated rate hike by the Fed. While CPI declined to 6%, in line with expectations, multiple economic releases for the week presented a softer economic environment with a flat industrial production for February, declining leading indicators, and a lower-than-expected University of Michigan consumer sentiment reading of 63.4.

The task at hand for the Treasury Department, FDIC, and global central banks is to continue to assure the market the safety and stability of the U.S. and global banking system. On March 16, Senate testimony Treasury Secretary Janet Yellen commented that uninsured bank deposits that pose a systemic market risk would likely be guaranteed but stopped short of a full guarantee on all bank failures. The second most important event for the week ahead is Wednesday’s highly anticipated FOMC interest rate decision. Market sentiment in light of the banking fears is the Fed will now act cautiously in fueling the banking and recession fears by being overly aggressive with its decision and rhetoric. The week ahead will also affirm the state of the housing market and the manufacturing sector as durable orders and PMI report.

Another Possible Fed Misstep Ahead

The Fed has announced its intention to continue raising rates to lower inflation. The model the Fed has embraced requires a reduction of the rate of growth of output to lower inflation. Raising rates is part of the effort to lower the growth rate of output. The Fed Chairman has argued real growth is too high and driving inflation. However, there are signs he has misread the state of the economy,

While raising the Fed Funds rate, the Fed has brought about a reduction in the growth rate of the money supply. The current rate of growth of M2 is negative, and growth at this level is consistent with a substantial slowdown in economic activity. A sustained further reduction in the growth rate will almost certainly produce negative economic growth. Ironically, due to the SVB bailout, the Federal Reserve loosened its borrowing guidelines for banks to encourage lending and, in effect, boosted the money supply – analogous to Quantitative Easing 5.0.

The year-over-year percent change for real disposable personal income has just become positive. During the period from April 2021 to January 2023, real disposable personal income declined. If the change does not remain positive, it will be difficult to sustain economic growth. In addition, stocks of companies in the consumer durables sector will likely face challenges while trying to generate growth in profits.

Consumer confidence could be more robust, and the current level is consistent with the weak real disposable income data. There has been some improvement in confidence, but should the economy slow down in response to the Fed’s efforts, confidence will surely diminish.

Existing home sales have declined from about 6,300,000 annually to approximately 4,000,000 over the last year. This decline is evidence that a resumption in economic growth at or near the long-term average of 3% is unlikely in the near term. Slowing housing sales typically lead to a slowdown in demand for consumer durables. If the damage from the SVB bankruptcy cannot be contained, then all bets are off.