The beginning of the end?

U.S. banking stresses continued to be felt in the market this week, despite strong government support for depositors and the regional banking system, with the focus shifting overseas to distressed Credit Suisse Bank (CS) being taken over by UBS over the weekend. While the deal initially calmed markets, the terms of the agreement saw some of their deeply subordinated Additional Tier 1 (AT1) securities get written down to zero ahead of common equity holders who may still see some recovery.

Economic data

This rattled debt markets across the globe, with Canadian financials also being impacted, particularly AT1 securities in our domestic market. In an effort to re-establish confidence, both the Bank of Canada and the Office of the Superintendent of Financial Institutions?(OSFI) released statements highlighting the strengths of the Canadian banking sector and how our AT1 securities are structured differently from those that were written down at CS.

However, while this did help improve market liquidity and contribute to modest improvement in valuations, markets remain on unstable footing. These stresses left many market participants questioning whether the Fed would continue to hike or pause this week, but ultimately the Federal Open Market Committee (FOMC) unanimously elected to increase rates by 0.25% to 4.75%-5.00%, albeit changing its statement to incorporate more dovish language with references to the uncertainties about spillover from the financial system issues. So while we did see the Fed continue to move forward in its ongoing efforts to cool inflation, its projections include only one more 0.25% rate increase in 2023, with the federal funds rate falling to 4.25%-4.5% in 2024. Markets reacted favorably to this news, interpreting Chairman Powell’s comments as a potential signal that the Fed is close to the end of its tightening cycle.

In other economic news, we saw stronger than anticipated U.S. existing home sales for February, increasing by 14.5% month over month to an annualized rate of 4.6 million. While still below normalized levels of approximately 5-5.5 million sales per year, this was a strong improvement from the 4.0 million pace seen in January and the first increase since early 2022.

Weekly jobless claims were also stronger than expected at 191,000, demonstrating the ongoing resilience of the U.S. job market despite efforts to cool the economy. In Canada, we saw the consumer price index (CPI) for February, which came in modestly softer than anticipated at 5.2% and down from 5.9% in January. But while the headline number was better than expected, core inflation continued to rise, with services seeing higher prices on a month over month basis. Still, this remains lower than projections from the Bank of Canada, which should continue to support their decision to leave the overnight rate unchanged at 4.50%. Lastly, Canadian retail sales for January came in stronger than expected at +1.4%, but the flash estimate for February was -0.6%, so the overall impact on the market was fairly muted.

Bond market reaction

Bond yields moved lower on the week, in response to instability in the banking sector and expectations that the Fed was getting close to the end of its tightening cycle. Also, while FOMC expectations do not see any rate cuts this year, futures markets are far more aggressive, pricing in cuts from both the Fed and the Bank of Canada within the next 6 months. So the market expects that something will break in the near term and we are clearly seeing cracks in the banking sector globally.

Consistent with these expectations, the yield curve, defined as the difference in yield between 30-year and 2-year bond yields, steepened on the week, as shorter dated bond yields saw a more pronounced move lower. Credit spreads continued to move wider on the week, despite dovish comments by Chairman Powell and enhanced efforts to stabilize the banking sector. However, the new issue market did unthaw, with multiple deals coming to the market and being well received.

Stock market reaction

Equity markets had done a valiant job this week of climbing the proverbial wall of worry higher until U.S. Treasury Secretary Janet Yellen spooked markets with her comments dismissing an expansion of insurance provided by the Federal Deposit Insurance Corporation (FDIC) and repeatedly mentioning credit concerns. Credit issues should have been an obvious concern, however investors had been looking past some of the recent bank turmoil as isolated to problematic institutions as opposed to being systemic in nature, perhaps naively.

Today, Deutsche Bank has refocused investors on the risks in the European banking system, and has caused much of the week’s equity gains to melt away. In the U.S., technology led the strength this week, while energy and materials boosted returns in Canada. Gold continues to flirt with the $2,000 per ounce psychological level, while oil rose approximately $7 per barrel inter-week. Unfortunately, the melancholy mood heading into the weekend saw oil slump back to $67 per barrel on recessionary fears and the impact that will have on demand.

What to watch next week

In the U.S. next week we’ll see the third revision to Q4 GDP, as well as personal income, spending, personal consumption expenditures (PCE), wholesale and retail inventories and pending home sales for January. We’ll also see the Conference Board Consumer Confidence survey for March. In Canada, we’ll see GDP and the Survey of Employment, Payrolls and Hours (SEPH) payroll employment report for January, as well as the Canadian Federation of Independent Business’ (CFIB) Business Barometer report for March.

Weekly roundup by: Patrick O’Toole, Adam Ditkofsky and Pablo Martinez

Related insights from CIBC Asset Management:

• Fed raises rates less than expected as worries about financial system stability loom
• Additional Tier 1 capital pressured after Credit Suisse takeover
• Views on investing in domestic and foreign bank stocks

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Patrick O’Toole is Senior Portfolio Manager, Global Fixed Income; Adam Ditkofsky is Senior Portfolio Manager, Global Fixed Income; and Pablo Martinez is Portfolio Manager, Global Fixed Income.

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