NO NEED FOR PANIC

Issue 278

By Jeffrey Trusheim, Chief Financial Officer, Mortgage Solutions of Colorado, LLC DBA, Mortgage Solutions Financial.

Mortgage Solutions presents Issue 278 of Market Pulse. This commentary will provide Trusheim's perspective of the economic, political, and technical considerations that will have an impact on the global & domestic financial marketplace. The report will provide a recap of the previous week's activity as well as a look at the important market-moving factors in the week ahead.

It was a week to remember (or maybe forget)! The equity markets cratered over 4%, Treasury Bond yields plummeted more than 40 basis points, and the Silicon Valley Bank became the second largest bank failure in U.S. history.?

The week started on a high note, with the S&P 500 trading just under 4100, and Fed Chairman Powell talking a bit more dovish with his recent disinflation comments. All of that ended on Tuesday morning. During his two-day testimony before Congress, Powell said that in light of recent economic data coming in stronger than expected, the FOMC was open to higher interest rates. The markets interpreted this to mean rates would go higher, faster, and stay there longer than previously expected. The futures market immediately put an 80% probability of a 50-basis point hike at the upcoming March FOMC meeting.?

The Thursday and Friday headlines were dominated by two bank failures. The liquidation of crypto-friendly Silvergate Bank, and the collapse of Silicon Valley Bank. SVB was seized by California Banking Regulators on Friday, and Receivership was immediately handed over to the FDIC (Federal Deposit Insurance Corporation). Insured depositors (up to$250k) will supposedly have access to their funds by Monday morning. Depositors with funds exceeding insurance caps will get receivership certificates for their uninsured balances, meaning that they are unlikely to get their money out soon.?

What is most interesting and very concerning is that Bank Regulators stated on March 8th (two days prior to the collapse) that SVB was “in sound financial condition).” SVB was the 16th largest bank in the U.S. and was ranked #20 on the list of the top 50 “Best Banks in America” by Forbes Magazine. The markets (stocks, bonds and precious metals) are now quite concerned of the SVB failure becoming a potential systemic event. How many other depository financial institutions are in the same shape, with an upside-down asset/liability mix?

This reminds me of the Savings & Loan Crisis back in the 1980’s. They were funding their long-term fixed rate mortgage loans (assets) with short-term floating-rate deposits (liabilities). It was fine when the S&L was paying 5% for deposits and charging 8% for a mortgage loan. However, when the Fed (Paul Volker) had to aggressively raise short-term rates (to 16%) to fight inflation, the S&L industry could count the days until they went bankrupt.?

The banking industry was flush with depositors’ cash (especially during the free money pandemic stimulus years), but with little loan demand. Much of that cash went into the government bond market, where yields were minuscule (1%-3%). Now the cost of deposits has moved well above the bond yields, causing massive negative returns, and in some cases causing the banks to liquidate their bond positions to meet regulatory requirements. A year ago, the fed funds rate was 0% and the yield curve was 40 basis points positive (steep). Now, the fed funds rate is 4.5% (on its way to 5.5%), and the yield curve is 100 basis points inverted. IMHO, this could be a prelude to a hard landing and serious credit event. Stay on your toes, and please take the time to study your banks balance sheet.?

By Friday afternoon, all hell broke loose. Fears of a contagion and liquidity crisis rambled through Wall Street. For the week, the Dow lost about 1,800 points and the S&P 500 sank about 180 points. The 10-year Treasury yield has now plummeted 42 basis points from its March 2nd high. The 2-year Treasury yield dropped from a high at 5.06% on Wednesday to a low at 3.57% on Friday, nearly 50 basis points in just two days! The 2-year/10-year spread traded to a negative 100 basis points last week…its worst level since 1981.?

As you might expect, these events have caused traders/investors to again adjust their expectations for a 50-basis point hike at the next FOMC meeting on March 22, down to less than 40% (from 80%), as they reassess the Fed’s willingness to threaten financial instability with continued rate hikes.?

Pay special attention to the CPI & PPI inflation reports on Tuesday and Wednesday this week. The expectation for headline CPI is a slight drop to 6.1%, with core inflation (ex. food & energy) at 5.5%, year-over-year.?

The monthly employment report showed a bit more jobs created than forecast (311k vs 225k), with the unemployment rate increasing to 3.6% (vs 3.4% expected). Average hourly earnings rose slightly to 4.6% (vs 4.7% expected). Decent report, with most of the jobs coming from low-paying service industries.

THE STOCK MARKET

The S&P 500 invalidated the bullish case last Wednesday, by first trading below important support at 4027, and then continuing lower in a five-wave impulsive structure and losing over 180 points in the process.?As mentioned in last week’s missive…it was important that any pullback be a corrective three wave structure. We may be stuck with the early February high at 4195 as being THE high for the bear mark correction from the October low. As mentioned many times before, I personally was using any trades in the 4100-4300 region as my exit points for equity holdings. We have had several opportunities to sell above 4100 in recent months, and it now seems possible that the corrective high has been struck at 4195.

A couple weeks ago I said that the important data in the coming weeks could rocket the S&P higher towards the 4300 region, or plummet it down towards 3800. Well, it looks like we are on the way to 3800 first. Take note of an historical fact that I posted last week: While in a bear market, S&P 500 has NEVER bottomed UNTIL AFTER the 2-year Treasury has hit its high yield. The 2-year Treasury hit what MAY be its high yield for this cycle at 5.06% last week. So, the October low for the S&P 500 at 3491 may prove to NOT be the bear market low. Could be different this time, but I’m not betting on it.?

Technically, I expect initial support to build in the 3700-3800 range in the weeks ahead, with a cluster of Fibonacci targets sitting in the 3760’s. It will now take a breakout above 3940 to begin building any bullish expectations.?

With important inflation data this week, a FOMC rate hike meeting next week, and possible contagion developing…anything is possible, and nothing would surprise me. I hope for the best but prepare for the worst. Beware…the Ides of March are upon us!

THE BOND MARKET

Bonds were schizophrenic last week! After hanging around the 4.00% level and getting comfortable with the Fed pushing the !0-year Treasury yield towards the 4.25% region…a massive flight-to-quality and safety took control of the market and tanked the yield all the way down to finish the week at 3.68%. That put the yield 29 basis points lower for the week, and 42 basis points lower from the March 2nd high. The terminal fed funds rate dropped to 5.3% from 5.7% on Friday, with rate cuts now expected to take the rate below 5% by year end.?

My bottom line: When I put my “what’s likely to happen” hat on my head, I find it highly unlikely that the Fed will allow any sort of financial contagion or bank liquidity crisis to materialize. The Fed and the FDIC working together have the tools necessary to calm the storm. Unsecured deposits at Silicon Valley Bank will either be bought by another bank or secured by the Fed. There are simply too many one-offs (many businesses with employees, title companies, start-up’s, etc.) that would go bankrupt, which would cause a contagion. The Fed cannot let that happen, especially with an inflation fighting and rate hiking agenda, while in a slowing economy. LO’s…GREAT TIME TO LOCK!

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Jeff Trusheim is the CFO of Mortgage Solutions Financial. Jeff is a 30+ year veteran in the Wall Street arena, with a background in economics, risk assessment and finance (banking and mortgage). He has previously worked in Fortune 500 companies in growing their portfolio and economic footprint.????