Week of March 20, 2023
Dec Mullarkey, CFA , Managing Director, Investment Strategy and Asset Allocation
As expected, the U.S. Federal Reserve raised rates by 25 basis points this week. Stress in the banking system led some to think the Fed might sit this one out. But a pause could well have sent a troubling message that the tools to fortify banking were not working. And Fed Chair Jerome Powell hit this upfront in his press conference. In summarizing the response, he emphasized that, “these actions demonstrate that all depositors' savings and the banking system are safe.”??
While it is necessary to bifurcate deposit support from taming inflation, there is little doubt that the banking scare will help the Fed by spreading caution and cooling activity. But the central bank needs to see how this plays out. In deference to this, the Fed softened its press release from prior updates to hint it would be more selective with future hikes.
But Powell was not the only one with a live bullhorn. At the same time, Treasury Secretary Janet Yellen was catching up with the Senate. And when pressed on bank deposit insurance, she made it clear she was not planning blanket guarantees – nor does she have the authority to do so. As those words hit, bank stocks in particular declined.
That should not have been a surprise as uninsured deposit support has been positioned as based on bank-by-bank evaluation, depending on the risk of contagion. To insure all deposits would require hefty insurance premiums from all banks, resulting in significant hits to profitability. On balance it seems like investors are still figuring out what the future of bank risk looks like.?
Source: U.S. Federal Reserve, 2023.
Linda Kong Ting, CFA , Senior Director and Credit Analyst, U.S. Total Return
It’s been a wild ride in bank bonds this week, and not in the way most of us expected. Swiss Additional Tier 1 (AT1) securities turned out not to be strictly senior to equity, and Credit Suisse senior unsecured paper outperformed that of its stronger acquirer, UBS. But even if you’re not sitting on a bunch of distressed or distressing bank paper right now, it’s tough to be optimistic on credit overall. Even though levels are wider, the quick snapback in the debt of U.S. global systemically important banks (G-SIBs) is begging to be sold, given that the slower-burn crisis at First Republic Bank has not reached resolution.
So, what looks interesting right now in investment grade public credit? Perhaps energy, in which just months ago the market was keenly focused on the secular underinvestment theme in that sector putting a floor on prices, as well as the chemicals sector, in which fertilizer prices are still near highs. In financials, we are more positive on the credit card issuer banks, insofar as spreads have already priced in significant stress in terms of both credit risk and deposit beta but with few of the hold-to-maturity (HTM) losses that caused the run on regional banks. Alongside those, we would be sellers of financing-dependent sectors like automotive due to continued credit tightening, and incrementally more cautious on REIT subsectors that have not yet shown significant weakness in this cycle, like multifamily, industrial, biotech and self-storage.
Source: Bloomberg, 2023.
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Andrew Kleeman , Senior Managing Director, Head of Corporate Private Placements
“Private market has liquidity.” This was a recent subject line for an email from an investment grade (IG) private credit secondary broker headlining a trade that had just been executed. While this refers specifically to a secondary trade, the IG private credit market has also been active pricing new issue deals while the public bond market has been quiet, only opening this week to the issuance of higher quality credits in the wake of the Silicon Valley Bank (SVB) failure and concerns about the health of smaller banks. While we have heard of a few private deals that have been postponed due to market volatility, the IG private credit pipeline, which includes a wide range of credit quality, sectors, geographies and structures, is largely intact with both issuers and investors engaged.
Issuers are encouraged to move forward by slightly lower coupons given the lower Treasury yields, and investors are attracted to wider spreads post-SVB. While we don’t know in which direction the markets will go from here, one of the potential attractive features of the private credit market can be its stability, and ability to underwrite and price complex opportunities whatever the market conditions are.
Source: Private Placement Monitor, Bloomberg, 2023.
Makai E. , Director, Municipal Credit Research
State and local government rainy day reserves remain strong across the U.S. Bolstered by receipts of over $350B in federal aid, along with double digit year-over-year growth in tax revenues, state and local municipalities have focused on growing key reserve levels to provide additional flexibility in the event of an economic downturn. The National Association of State Budget Officers’ historical data show the median rainy day fund balance across states reached to levels of more than double than what was recorded during the Global Financial Crisis of 2007–8 (11.9% of spending in 2023 compared to 2.6% in 2009), and rainy day fund balance levels are up over 70%, since the beginning of the pandemic ($136.8B in 2023 versus $79.1B in 2019). In general, this increased flexibility will continue to allow states and local governments to manage potential financial difficulties as economic headwinds arise. As such, SLC Management continues to view U.S. municipal credit favorably.
Source: National Association of State Budget Officers, 2023.
Market insights are based on individual portfolio manager opinions and market observations. These are observations only and are not intended to provide specific financial, tax, investment, insurance, legal or accounting advice and should not be relied upon and does not?constitute a specific offer to buy and/or sell securities, insurance or investment services. Investors should consult with their professional advisors before acting upon any information posted here.
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