"Confidence... thrives on honesty, on honor, on the sacredness of obligations, on faithful protection and on unselfish performance. Without them it cannot live."
-Franklin D. Roosevelt
At the very foundation of the banking system is confidence. As a depositor, you need to have confidence that when you want to get your money from the bank ... it will be there. Bank runs inevitably occur when there are questions about the safety and accessibility of those deposits.
We have witnessed this dynamic firsthand in the last week with failures and distress in the regional banking sector. Prior to the last week, the largest bank failure in U.S. history occurred in 2008 with the failure of Washington Mutual. The next two on that list are Silicon Valley and Sovereign Bank with roughly ~$327 billion in assets, which in total is more than WAMU.
For now, the FDIC appears to have steadied the ship and restored confidence in the U.S. banking system by guaranteeing all deposits at both banks, the Federal Reserve offering cash loans of up to a year for any bank putting up safe collateral, and the consortium of banks led by JP Morgan depositing $30BN in First Republic. Will this be enough to restore confidence? Possibly, though only time will tell on this one.
Hopefully, the irony of JP Morgan being at the forefront of shoring up confidence by providing liquidity and deposits to First Republic in this crisis is not lost on you. As the man himself, John Pierpont Morgan, was critical in shoring up confidence during the banking crisis of 1907.
Ultimately, progressives at the time were not happy with the role that J.P. Morgan and his cadre of private bankers played in this crisis due to their unseemly profits coming out the other side. So, the banking crisis ultimately had a dire consequence, it led to The Federal Reserve Act and the creation of the Fed . . .
Back to the Global Macro Grind . . .
Speaking of which, a key question facing stock market operators next week will be the Federal Reserve’s resolve in fighting inflation. Will the Fed “thrive on honesty, on honor, on the sacredness of obligations . . .”? Or will the Fed lose our confidence in the fight against inflation?
Now, you may also be in the camp that the Fed has done enough already. After all, the fastest rate hiking cycle in our investing lifetimes is certainly noteworthy (and crisis inducing). In addition, many conventional measures of inflation, such as CPI and PPI, have decelerated meaningfully from their peaks, so perhaps there is a case to be made for a pivot in policy.
Interestingly, despite the woes at Credit Suisse, the ECB stayed with their hawkish guns and hiked rated by 50bps. The ECB stuck with their plans despite of the mayhem in the global banking sector. Now to be fair, CPI in the Eurozone is currently running at +8.5% Y/Y and the ECB has only raised rates to 3.0%, so any lack of resolve would have surely led to some loss of confidence in the ECB. Especially given the fact that Eurozone CPI came in this morning at 8.5% Y/Y, which was the same as last month.
Admittedly from a data perspective, the story is different in the U.S. where CPI is at 6.0% Y/Y and the effective Fed Funds Rate is at 4.58%. Clearly, the ECB had more work to do as compared to the Fed. That said, at 4.58%, the Effective Fed Funds rate still remains below its long run average back to 1954 of 4.60%, while CPI remains well above its long run average of 3.6% over the same period. So, there is still a disconnect between inflation and policy.
Also, don’t forget what Powell said in his Semiannual Monetary Policy Report to Congress less than two weeks ago:
“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.“
Clearly, the Fed lost our confidence with the “inflation is transitory” rhetoric, which then ultimately led to the unprecedented pace of interest rate hikes as inflation spiraled out of control. Now the question is whether Powell can maintain the confidence that he is serious about fighting inflation or at a minimum doing what he says he will do. We shall see next week, but you shouldn’t totally write off the scenario that the Fed continues to hike akin to the ECB, despite those begging for cowbell.
The combination of a banking crisis and confusion as it relates to the direction of Fed policy has led to an unprecedented increase in bond volatility. In the Chart of the Day, we highlight the MOVE index, which tracks bond volatility. Yesterday, the MOVE peaked at 198, which is effectively the highest level of bond volatility in the history of the data series, with the exception of a small period of time during the Great Financial Crisis.
As volatility in assets increase to unprecedented level, the risk of an even more meaningful crisis and move in asset prices accelerates. But since we are all very confident in the Fed’s “faithful protection and unselfish performance”, there is probably noting to worry about . . .
Given all of the cross currents globally, it is probably doesn’t surprise you that we remain positioned conservatively. At the moment, our Top Macro ETFs By Rank (which are updated daily via Macro Pro) are: FDRXX (cash), UUP, GLD, PFIX, BTAL, KRBN, BNDD, SQQQ, and ITA.
Immediate-term Risk Range™ Signal with @Hedgeye TREND signal in brackets
UST 30yr Yield 3.60-3.99% (bearish)
UST 10yr Yield 3.38-4.11% (bearish)
UST 2yr Yield 3.65-5.18% (bearish)
High Yield (HYG) 72.39-74.56 (bearish)
SPX 3 (bearish)
NASDAQ 11,038-11,828 (bearish)
RUT 1 (bearish)
Tech (XLK) 134-144 (bearish)
Defense (ITA) 110-117 (neutral)
Shanghai Comp 3 (bullish)
DAX 14,621-15,321 (bearish)
VIX 21.22-29.31 (bullish)
USD 102.98-106.26 (bullish)
Oil (WTI) 66.06-74.25 (bearish)
Gold 1 (bullish)
Copper 3.79-4.03 (bearish)
Bitcoin 18,796-26,935 (bearish)
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
