March 22, 2023 | Kathy Bostjancic

Fed delivers a dovish 25bps rate hike

• The FOMC recognizes in the policy statement that the fallout from the banking crisis will lead to tighter credit conditions for households and businesses and that will weigh on economic activity, employment, and be disinflationary. How much is uncertain.  This is all in line with our view, but ultimately the tightening of lending standards, which were already tightening, will lead to a moderate recession unfolding in H2 2023. We forecast a peak-to-trough contraction in GDP of 1.5%, just slightly less than the average 2% decline posted post-WWII excluding the Great Financial Crisis and the Covid-induced recession.
• Fed officials “will closely monitor incoming information and assess the implications for monetary policy - some additional policy firming might be needed.”
• The FOMC's dot plot estimates indicates that 10 of the 18 FOMC members forecasts one more rate hike and they are done tightening this cycle – one and done. One officials already sees them having reached the terminal rate, while seven others see higher rates, with one seeing 5.875% - higher than 5.6 in December dot plot
• The other dot plot estimates and macro forecasts little changed for 2024 and 2025.
• Taken together, a dovish 25bps rate hike, but we will await comments from Chairman Powell.

The information provided by Nationwide Economics is general in nature and not intended as investment or economic advice, or a recommendation to buy or sell any security or adopt any investment strategy. Additionally, it does not take into account any specific investment objectives, tax and financial condition or particular needs of any specific person. The economic and market forecasts reflect our opinion as of the date of this report and are subject to change without notice. These forecasts show a broad range of possible outcomes. Because they are subject to high levels of uncertainty, they will not reflect actual performance. We obtained certain information from sources deemed reliable, but we do not guarantee its accuracy, completeness or fairness. Nationwide and the Nationwide N and Eagle are service marks of Nationwide Mutual Insurance Company. © 2023 Nationwide [NFM-22503AO]

March 13, 2023 | Kathy Bostjancic

Silicon Valley Bank Collapse, Early Analysis

• In the fallout from the sudden collapse of Silicon Valley Bank (SVB), the debate now centers on whether the Fed holds rates steady or continues to increase the policy rate by 25bps on March 22. We believe a 50bps rate hike has been taken off the table, even if the February CPI report shows inflation remains uncomfortably high. If financial market conditions remain volatile, the Fed might even skip raising rates on March 22, which looks increasingly likely. This does not preclude the Fed from resuming its rate hikes starting in May, but it will depend on many factors. It is now clear that inflation is not the sole focus of the Fed, as it now needs to take into consideration financial stability and lending conditions.
• The Fed, Treasury and FDIC have taken the extraordinary step of creating another new funding program that makes all depositors at SVB whole and allows banks to pledge U.S. Treasuries, agency debt and mortgage-backed securities, and other qualifying assets as collateral at par. While this mitigates the risk of asset fire sales by banks and reduces the odds of spillover bank-runs, the fragility of and stress evident in the banking system likely gives Fed officials great pause.
• SVB’s collapse underscores what many feared from the record pace of tightening – 450bps over 11 months – a financial system or markets breakage. It is also hard for the Fed to make the case that financial conditions are easy and that the cumulative amount of Fed tightening has had little adverse impact on the financial system. Moreover, going forward banks, especially small and medium-sized banks, are likely to tighten their credit standards significantly despite the generous backstopping of the new Bank Term Funding Program.
• Fed officials need to consider that more cautious bank lending will be an additional brake on economic activity, and it could be significant.  Additionally, officials will need to worry about the prospect for large negative impacts on consumer and business confidence — though this should be dampened by yesterday’s bold action — that could cause both consumer and business spending to recoil, slowing the economy more abruptly than expected.
• In all, we think there will likely be a negative hit to investor, consumer, and business confidence despite this bold and necessary action. Such failures of large banks, and concerns about medium- and small-sized banks, likely rattles nerves and begs the question, what’s next to break? We see the unfortunate banking developments and ensuing tightening of lending standards as reinforcing our view that the economy is headed for a recession in the second half of 2023.
• This puts the Fed in a less desirable position and likely reduces its hawkish mood.
• As for the impact of the new Bank Term Funding Program (BTFP) on the Fed’s balance sheet; like other Fed funding programs introduced during the height of the pandemic and the Great Financial Crisis, it will likely expand the size of the balance sheet, in opposition to the Fed’s current endeavors to do the opposite. How much will depend on the degree the new program is tapped. These opposing actions on the balance sheet also appeared when the Bank of England intervened to shore up pension funds. On the margin, this makes monetary policy less restrictive – but rates are still the primary policy tool. We might also see an uptick in  discount window usage but assume the new facility will see most of the flows.

The information provided by Nationwide Economics is general in nature and not intended as investment or economic advice, or a recommendation to buy or sell any security or adopt any investment strategy. Additionally, it does not take into account any specific investment objectives, tax and financial condition or particular needs of any specific person. The economic and market forecasts reflect our opinion as of the date of this report and are subject to change without notice. These forecasts show a broad range of possible outcomes. Because they are subject to high levels of uncertainty, they will not reflect actual performance. We obtained certain information from sources deemed reliable, but we do not guarantee its accuracy, completeness or fairness. Nationwide and the Nationwide N and Eagle are service marks of Nationwide Mutual Insurance Company. © 2023 Nationwide [NFM-22503AO]
 

March 13, 2023 | Mark Hackett

Banking system fears cause sharp bond market reaction

Thoughts 

• Equity markets look to stabilize following a difficult week that saw several bank closures, resulting in the largest weekly decline since September 2022. Last week was a reminder of the underlying pessimism of institutional investors, along with the fragility of the market. The sell-off was broad-based, led by small caps, value, and emerging markets. The S&P 500® Index begins the week less than 1% above the level from the beginning of the year, dropping 7% from early February. Volatility has returned in force, with the VIX at the highest level (29) since October, while the MOVE Index (measuring bond market volatility) up 43% since early February. As has been the case since the beginning of last year, bond investors are exhibiting greater signs of emotion than the equity market, which is unusual during periods of uncertainty. 
• The bond market continues to post extreme volatility, including a roughly 0.50% drop in the 2-year yield on Monday, registering the largest two-day drop since the financial crisis, and suggesting investors are rapidly shifting their expectations for Fed policy. The federal government stepped up to support the banking system with a pledge to support depositors above the FDIC’s $250,000 insurance cap, potentially introducing a “moral hazard,” essentially uncapping the FDIC threshold in the minds of depositors. This volatility could continue over the next two weeks, with contagion in the banking system a concern, a reading on CPI and PPI coming this week, and an FOMC meeting next week. 
• The Fed's new Bank Term Funding Program, combined with the temporary expansion of FDIC insurance announced yesterday, effectively solved for any fundamental concerns regarding bank solvency or liquidity related to held-to-maturity securities portfolios, which has been an area of focus over the past week. 
• Today's movement in bank equities, rather, is emotion driven. But that fear isn't pervasive. Two data points are instructive here: First, CNN's Fear & Greed Index has seen a wholesale shift towards fear (from 78-Extreme Greed to 18-Extreme Fear) in only 40 days. At the same time, overnight interbank lending rates have remained relatively stable and low, by historical standards, at 0.29%. If all things stay the same, this will likely be a buying opportunity once the dust settles. 

News 

• The health of the banking system has been under scrutiny over the past week with the collapse of several banks. Regulators shut down Silicon Valley Bank, with $211 billion in assets and $173 billion in deposits, following a run on the bank late last week. On Sunday, the Treasury Department, Federal Reserve, and the FDIC announced actions to restore confidence in the banking system, pledging to “fully protect all depositors” at SVB despite roughly 97% of deposits above the $250,000 FDIC insurance threshold. Additionally, the Fed announced a new “Bank Term Funding Program” offering better terms on one-year loans to banks, along with relaxing terms at the discount window, the primary direct lending facility. The KBW Bank Index lost 16% last week, the worst since the beginning of the pandemic. 
• Investors are struggling to gauge the direction of Fed policy with the banking industry struggles contrasted with the stubbornly high level of inflation. The terminal rate has fallen to 4.79% on Monday, down nearly 1.00% since a week ago, and down 0.20% from the beginning of the year. The Fed Futures curve now embeds a near 50-50 split between no action at next week’s FOMC meeting and a 0.25% hike. It was near 50-50 between a 0.25% and a 0.50% hike last week following hawkish commentary by Fed Chair Powell to Congress, where he stated that we will see “higher than previously anticipated” rates for an extended period. “The latest economic data have come in stronger than expected, which suggests that the ultimate level of interest rates is likely to be higher than previously anticipated,” Powell told the Senate Banking Committee. “If the totality of the data were to indicate that faster tightening is warranted, we would be prepared to increase the pace of rate hikes.” It is unclear how the disruption in the banking system may impact that path. 
• Payrolls in February were a stronger-than-expected 311,000, better than the 225,000 estimate, but down from 504,000 in January. According to Bloomberg, payrolls have topped estimates for 11-straight months, extending the longest streak since 1998. The unemployment rate ticked higher to 3.6% from 3.4% last month despite strong job growth, as the labor force participation rate rose. Average hourly earnings grew by 4.6% from a year ago, slightly lower than estimated, but faster than in January. CPI estimates for next week at 6.0% headline (5.5% core), suggesting a 23rd straight month of negative real wages. The JOLTS report showed 10.8 million job openings, down from 11.2 million in January, but still much higher than the 5.8 million unemployed people. 
   

What to Watch 

• Inflation will be in focus next week, with reports on CPI on Tuesday and PPI on Wednesday. Other notable releases include the NFIB Small Business Index on Tuesday, retail sales on Wednesday, housing starts on Thursday, and industrial production, leading indicators, and consumer sentiment on Friday. 
   

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March 10, 2023 | Kathy Bostjancic

February employment: Supply of labor rises, easing tight labor conditions

• While the number of jobs created in February exceeded expectations yet again, rising a strong 311,000 following the stunningly strong 504,000 gain in January, this was offset by another encouraging rise in the labor force participation rate which underscores the anecdotal reports from surveys and companies that they are finding it easier to find workers.
• The rise in the participation rate helped lead to a rise in the unemployment rate from 3.4% to 3.6%, signaling some easing in the mismatch between supply and demand for labor, albeit the labor market remains very tight.
• Most positive, the easing of labor conditions is leading to slower wage increases as average hourly earnings rose just a modest 0.2%, continuing the downward monthly trend. Due to difficult year-on-year comparisons however the annual pace rose to 4.6% from 4.4%.
• The average number of hours workers worked also fell, which suggests a less taut labor market.
• In all, the data do not argue for a 50bps rate hike by the Fed on March 22 despite the strong payroll advance. The Fed can take comfort in the rise in the supply of labor and the easing of upward pressure on wages to maintain a 25bps rate increase.  However, the February CPI report will also weigh heavily in the Fed’s deliberations of whether to raise rates 25bps or 50bps. Another rapid rise in consumer inflation could tip the scales towards 50bps. 

The information provided by Nationwide Economics is general in nature and not intended as investment or economic advice, or a recommendation to buy or sell any security or adopt any investment strategy. Additionally, it does not take into account any specific investment objectives, tax and financial condition or particular needs of any specific person. The economic and market forecasts reflect our opinion as of the date of this report and are subject to change without notice. These forecasts show a broad range of possible outcomes. Because they are subject to high levels of uncertainty, they will not reflect actual performance. We obtained certain information from sources deemed reliable, but we do not guarantee its accuracy, completeness or fairness. Nationwide and the Nationwide N and Eagle are service marks of Nationwide Mutual Insurance Company. © 2023 Nationwide [NFM-22503AO]