Evening Brief – 03.30.23

The scale of financial issues now is not like 2008 – so far. In 2008, the US was writing off billions in sub-prime mortgage debt that had ballooned during the boom years. Banks are less exposed to this kind of debt than in the past. This time is unusual in the sense that the Fed has made it clear it will lend to banks, in both the standard discount window and the new weekly BTFP program.

Today’s potential crisis differs from previous ones also because it’s the other side of the balance sheet that is the culprit, and some investors have a hard time understanding it; they can understand bad loans, but it’s hard to grasp how billions of dollars of US government bonds can be a bad thing.

No one knows if there is another banking crisis or failure on the horizon, but everyone acknowledges that modern communications and social media make the transmission of a crisis mentality quick as lightning, even quicker than 2008.

While most market participants believe the US economy is still strong, faith is low in the banking sector’s management, and to some degree the government’s regulatory capabilities.

For the moment, a fresh banking crisis has not reared its ugly head. The KBW bank index is steady, although well off its February highs. The 2-year yield is back above 4% and the 2s/10s yield curve inversion – the recession predictor – is holding steady around -41bps, better than -107bps on March 8.

And the CME FedWatch tool shows 52.3% expect the Fed to keep rates the same at the May 2-3 meeting with 41.2% expecting another 25bps hike. This is what Powell wants to see. But we can’t count on these metrics to last.

We have had bank collapses in the past without a major credit crunch, but we live in uncertain times, and the dichotomy of high inflation and bank failures leaves policymakers with an unenviable situation.