Welcome to the Ides of March, a date known in Roman times as a deadline for settling debts. This historical precedent seems eerily coincidental as, coming into the week of March 13, it felt like financial markets were in line to pay off borrowed results and settle up with the macroeconomic backdrop, especially the Federal Reserve’s (Fed’s) higher-for-longer interest rate stance.
As we are only a few days removed from multiple bank failures, including the second and third largest banks to ever fail, investors are naturally unnerved. While we have seen huge swings in certain parts of the market, overall, the March 13 and 14 were surprisingly less dramatic than expected. However, March 15 brought new concerns regarding European banks, starting with Credit Suisse.
Here is a quick primer on the situation:
- Credit Suisse has been in the headlines for over a year about its complex internal restructuring, which has left it vulnerable to outflows as customers and shareholders question the company’s ability to pull it off. The recent U.S. bank failures have exacerbated these vulnerabilities.
- Credit Suisse’s management has assured investors its financial position is sound and the bank does not face the same liquidity challenges that impacted the failed banks.
- However, the company’s largest shareholder, Saudi National Bank, raised concerns by announcing it would not provide additional funding due to regulatory restrictions.
- Shares of Credit Suisse tumbled more than 25%, and shares of other European banks fell in sympathy. Furthermore, the cost to insure bonds of Credit Suisse increased dramatically, indicating rising concern over its possible failure.
While it is too soon to draw conclusions, we wanted to share some perspectives from the Investment Strategy team.
What surprises us most?
The resilience of credit markets throughout these turbulent times is worth noting. Credit spreads have been surprisingly stable during most of this Fed tightening cycle. After three bank failures, we would have expected credit to be first to settle up with the market. However, high yield option-adjusted spreads (OAS) remain below where they were during relatively recent significant market events (Figure 1). These include in 2016, when then Fed Chair Janet Yellen could not rule out the potential for negative interest rates; in 2018, the last time the Fed engaged in an interest rate tightening campaign; and finally, in 2020, during the global pandemic. Credit markets remain a primary focus for us through this part of the business cycle. .
Figure 1. Bloomberg U.S. Corporate High Yield Index OAS (bps)
High-yield spreads holding for now
As of 3/15/2023. Source: Bloomberg, L.P.
View accessible version of this chart.
What have we learned?
While the situation remains fluid, we have learned the Fed still has tools in its toolkit, even as its interest rate hiking campaign to quell inflation continues.
With fears of financial contagion from bank failures rattling markets, the Fed, U.S. Treasury and Federal Deposit Insurance Corporation partnered to help stabilize the U.S. banking system. The trio of agencies introduced a set of measures to support depositors of the affected banks and bank liquidity more broadly. Given these measures appear to have contained fears for now, we believe the Fed could press ahead with its anticipated interest rate increase the week of March 20, particularly after an inflation report on Tuesday, March 14 showed inflation still hovering at 6%. However, the size of the rate increase could come down to 25 basis points (bps) from 50 bps, as was widely expected until recently. Today’s decline in the producer price index report provided further evidence the economy may be slowing, which could help bring us closer to the Fed’s terminal rate.
The other lesson we have learned is investors are still concerned about the Financials sector. While the Fed’s Bank Term Funding Program has seemingly snuffed out contagion risk, investors remain unconvinced. As we have seen worries flare about European financials, the performance of U.S. financials has suffered as well. Using the S&P Regional Banks Select Industry Index as a proxy, regional banks were down roughly 20% in the three trading days prior to March 14 (Figure 2). As of right now, continued concerns are precluding an “all clear” for markets.
Figure 2. S&P Regional Banks Select Industry Index
Regional bank stocks under pressure
As of 3/15/2023. Source: Bloomberg L.P.
View accessible version of this chart.
What happens next?
Increased market volatility — the debt collector in our Ides analogy — has been the least surprising part of the week. The CBOE Volatility Index climbed to a near-term high today, a level not seen since November 2022, after Chair Powell’s August 2022 Jackson Hole speech spurred volatility throughout the fall (Figure 3).
Figure 3. CBOE Volatility Index
Equity volatility up sharply
As of 3/15/2023. Source: Bloomberg L.P.
View accessible version of this chart.
In fixed income markets, the ICE BofAML MOVE Index has climbed to its highest level since the pandemic in 2020 (Figure 4). Rightfully so, as on March 13, 2-year U.S. Treasury yields experienced the single biggest move down since 1982! This clearly highlights investors’ “flight to safety.” In just a matter of days, the 2-year Treasury yield has dropped more than 100 bps. We believe moves like this portend uncertainty ahead.
Figure 4. ICE BofAML MOVE Index
Fixed income volatility at a once-year peak
As of 3/15/2023. Source: Bloomberg L.P.
View accessible version of this chart.
What are we watching?
While markets are dynamic and ever-changing, we have a keen eye on arguably the single biggest driver of market behavior over the last year — the Fed. The March 21-22 Federal Open Market Committee meeting and expected rate announcement will be telling. We expect a 25 bp move higher, but for the first time in a long time, there is some discord in market sentiment, with some participants calling for a pause based on recent events. More important to the market’s path forward, in our view, is a line of sight to the Fed’s terminal rate. Until the Fed and the market align on the terminal rate, we expect investors will pay the debt of volatility for potential results.
Accessible Version of Charts
Figure 1. Bloomberg U.S. Corporate High Yield Index OAS (bps)
(view chart) High-yield spreads holding for now
Date |
Index OAS to Treasury Curve Basis Points |
3/2013 |
448.579712 |
3/2015 |
453.966705 |
3/2017 |
381.739624 |
3/2019 |
384.906403 |
3/2021 |
336.636688 |
3/2023 |
468.600006 |
As of 3/15/2023 | Source: Bloomberg, L.P.
Figure 2. S&P Regional Banks Select Industry Index
(view chart) Regional bank stocks under pressure
Date |
S&P Regional Banks Select Industry Index |
3/2022 |
3432.27 |
7/2022 |
2898.27 |
11/2022 |
3206.56 |
3/2023 |
2271.27 |
As of 3/15/2023 | Source: Bloomberg, L.P.
Figure 3. CBOE Volatility Index
(view chart) Equity volatility up sharply
Date |
Last Price |
3/2022 |
29.83 |
5/2022 |
27.47 |
7/2022 |
24.23 |
7/2022 |
24.23 |
11/2022 |
24.54 |
1/2023 |
19.49 |
3/2023 |
26.55 |
As of 3/15/2023 | Source: Bloomberg, L.P.
Figure 4. ICE BofAML MOVE Index
(view chart) Fix income volatility at a one-year peak
Date |
Last Price |
3/2022 |
101.03 |
5/2022 |
117.95 |
7/2022 |
129.85 |
7/2022 |
124.07 |
11/2022 |
128.62 |
1/2023 |
122.27 |
3/2023 |
169.65 |
As of 3/15/2023 | Source: Bloomberg, L.P.
