Market Update: Wild Ride
US equity indexes were down on the week: S&P 500 -4.6%, NASDAQ -4.7%, and DJIA -4.4%. It was a wild ride for both US equities and government bonds. The VIX Index jumped from 18.6 on Monday to over 24 on Friday. Fed Chair Powell's semi-annual economic testimony and the US February jobs report were overshadowed by the financial turmoil of lender Silicon Valley Bank ("SVB") later in the week, which caused liquidity and contagion concerns for the wider US banking sector. Below, we discuss events chronologically.
On Tuesday, Fed Chair Powell came out swinging in his Semiannual Monetary Policy Report to the Congress. His comments were hawkish suggesting that the rate hike pace could be increased after the Fed had just slowed the pace.
Powell stated: "...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. 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." In reaction, US equity indexes fell on the day (Tuesday) and the US 2 year yield moved above 5.00%.
But then, risk-off happened suddenly and all at once: On Thursday, US bank stocks and wider US equity indexes were down sharply with Silicon Valley Bank ("SVB") as the catalyst.
For background, it is important to note that SVB is unique in the banking industry as its deposit base is overwhelmingly businesses, concentrated in Silicon Valley start-ups. According to SVB's website: "44% of U.S. venture-backed technology and healthcare IPOs YTD bank with SVB."
As SVB was the go-to bank for Silicon Valley start-ups and venture funds, it had an inflow of deposits during the tech-led investment boom post the start of the covid pandemic. SVB invested them in longer-dated US government bonds, as opposed to lending them out. These were relatively low yielding and when the Fed raised rates quickly, deposits became more expensive. Usually businesses (the majority of SVB's depositors) demand higher interest rates when rates rise. Good further discussion in FT here.
As a result of the profit squeeze, on Wednesday, SVB announced a USD 1.75 billion share sale to shore up its balance sheet due to the fact that it had "sold approximately $21 billion of securities, which will result in an after tax loss of approximately $1.8 billion in the first quarter of 2023." However, his raised concern among depositors and investors. SVB's shares fell 60% on Thursday as some notable Silicon Valley venture funds withdrew their funds and advised others to do so as well. According to WSJ, SVB had USD 42 billion in attempted withdrawals on March 9 (see here) - a bank run. Market participants feared a sector wide banking problem with bank's respective bond portfolios. As a result, the KBW Bank Index, which represents national money center banks and leading regional institutions, fell 7.7% on Thursday. US bank stocks were down heavy taking US equity indexes lower on the day as well and US bond yields backed off.
On Friday morning, SVB trading was halted. Just before Noon EST, it was announced that SVB had failed and that the FDIC was taking it into receivership. This is the second largest US bank failure in the US history by assets. (See WSJ graphic here.) The KBW Bank Index fell 3.9% on Friday, but, in the underlying components, larger banks JP Morgan and Wells Fargo were in positive territory - signaling confidence in the larger US banks (as opposed to regional banks, most of which were down in the KRX Index for regional banks). Reuters, over the weekend, reported that regulators urged SVB to find a buyer. Bloomberg reports that the "Federal Reserve and FDIC are weighing creating a fund to backstop more deposits at banks that run into trouble post SVB's collapse." It would be focused on smaller banks with venture clients.
Friday morning was busy with the February US Payroll release as well. US payrolls came in above expectations at 311k (vs 225k expected). There was minimal revision to January's blockbuster result (504k revised vs 511k). The unemployment rate moved up to 3.6% from 3.4%. Average hourly earnings rose less than expected, up just 0.2%. The February payroll result was solid, but there was not enough surprise (upward or downward) to gain market participants' attention which was focused on the rapidly unfolding SVB events.
Looking at Fed Fund Futures on Friday, the terminal rate is now expected to peak in July at 5.26% (lower and earlier than what was priced last Friday). There is approximately 37bp of rate cuts priced in by year-end. The probability of a 50bp rate hike at the March meeting changed dramatically over the course of the week. A 25bp rate hike is now priced as slightly more likely - see chart here.
The SVB experience shows that the impacts of the long and variable lags from Fed tightening are difficult to anticipate. Events can unfold in non-liner ways. The economy and financial markets are sending different signals and the Fed will have to navigate both fighting inflation and maintaining shorter term financial stability while doing so. It is likely that periods of sharp risk aversion could continue to appear throughout the year given the unusually aggressive nature of this Fed tightening cycle. This should support safe haven assets such as USD, CHF, gold, and the diamond commodity.
Chart: US 2 year yield's wild ride this week
Turning to the Diamond Commodity:
DIAMINDX was flat on the week, remaining at USD 5,410.
On a positive note, Mastercard SpendingPulse, which measures in-store and online retail sales across all forms of payment, reported that for January, "After 9 months of stagnant growth, Jewelry was up +6.5% YOY, potentially reflecting early Valentine’s Day shopping."
The DeBeers Group site 2 results were released and rose 9% from site 1. Rapaport reports that De Beers raised prices on small rough for the second month in a row. However, results were down 24% y/y as 2022 had been off to a strong start. Al Cook, CEO of De Beers Group, commented:
“In this, my first Sight update to the market, I am pleased to see continued steady demand for rough diamonds in line with our expectations for sales as the year progresses. For example, we know that Sightholders planned more of their purchases for later in 2023, given the economic uncertainty at the time they were taking their planning decisions at the end of 2022. It is also encouraging to see some positive trends in end client demand for diamond jewellery at the start of the year.”
With market turmoil brought on by SVB, gold was up late in the week. It gained 0.95% on Thursday and 1.8% on Friday. On a weekly basis, gold rose 0.4% and broke topside USD 1,850 to come in at USD 1,864.
Silver was not able to build on its momentum from last week and fell 3.8% on the week. Hawkish Fed statements weighed on it. It ended the week at USD 20.45 above support of USD 20.00.
Chart: DIAMINDX, Gold, and Silver YTD.
USD waxed and waned with the events described above. The DXY Index ended basically flat on the week at 104.62. Other safe haven currencies JPY and CHF rose vs USD given that the risk-off SVB events were US based. The safe-haven CHF was the strongest performing G10 currency this week vs. USD, rising 1.6% (chart below). Risk-seeking currencies (AUD, NZD, CAD) fell vs USD as US equities finished the week lower. AUDUSD was the worst performing G10 currency this week, falling 2.8%. EURUSD was basically flat, ending the week at 1.0640.
__Chart: The jump in the VIX Index vs USDCHF (inverted, ls). Re USDCHF, when line moving up, CHF strengthening vs USD. __
__Ahead - select events include: __
The big data event next week is US CPI for February - a key data point heading into the FOMC meeting March 21-22.
Tuesday, March 14
US CPI (Feb): Bloomberg consensus expects a 0.4% m/m rise in the headline to come in at 6.0% y/y and a 0.4% m/m rise in core CPI to come in at 5.5% y/y.
Wednesday, March 15
US Retail Sales (Feb): Bloomberg consensus expects a -0.4% m/m fall in the headline pulled down by autos and a -0.2% fall in the core retail sales. __ Thursday, March 16__
ECB Monetary Policy meeting: a 50bp rate hike is expected. The market's focus will be what comes next. __ Friday, March 17__
US U of Michigan Sentiment (Mar Prelim)
This report has been prepared by the Strategy Team of Diamond Standard Inc. (“Diamond Standard”). This report, while in preparation, may have been discussed with or reviewed by persons outside of the Strategy Team, both within and outside Diamond Standard. While this report may discuss implications of legislative, regulatory and economic policy developments for industry sectors, it does not attempt to distinguish among the prospects or performance of, or provide analysis of, individual companies and does not recommend any individual security or an investment in any individual company and should not be relied upon in making investment decisions with respect to individual companies or securities.
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