(Bloomberg) — Two brutal weeks for banks have ended most hopes in markets that a US recession can be avoided. But a closer study of the cross-asset landscape still finds investors unconvinced that the stress reflects a real financial crisis.
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From stocks to credit to the breakdown of inflation and the dollar, the message is one of growing pessimism about economic growth that hasn't turned into panic about systemic collapse — yet. Moves like the 5.8% jump in the Nasdaq 100 this week tell a tale of investors shaken by the failure of three US banks and the wobble of Credit Suisse Group AG, while resisting the sell-it-all ethos that marked the 2008-like catastrophe. Are.
“Everybody's talking bearish, but they're not acting that way,” said Matt Malley, chief market strategist at Miller Tabak + Company. “The market is definitely indicating that we will avoid a full blown crisis.”
Of course, things change – more bank failures this weekend will change the calculus, and it's risky to draw firm conclusions from any snapshot in time. Crises don't come all at once. What appears to be calm now could be the opening innings of disaster. So far, however, the market backdrop has yet to distinguish itself from other moments that haven't ended in blows.
For a zoomed-out picture, a global cross-asset market risk indicator put out by Bank of America Corp rose this week to its highest level since October, while reaching levels down during the pandemic and 2008. The metric measures the level of stress in financial markets. Measuring implied future price volatility by options markets in global equities, rates, currencies and commodities.
“It's not surprising with all the dramatic events that we're seeing a lot of volatility in prices,” Lisa Erickson, head of the public markets group at US Bank Wealth Management, said by phone. “The markets are indeed reflecting a greater level of uncertainty and we see this through rapid changes in pricing.”
Across all markets, the most concrete sign of a recession is a decline in Treasury yields. Sinking further Friday, the bearishness was led by short-dated bonds, which took the entire yield curve below 4% as banking turmoil prompted traders to price in more Federal Reserve rate hikes. But not every fixed-income instrument is showing doom.
Rates at the two-year breakeven — a proxy for where bond traders see inflation over a few years' time — have declined over the past few weeks after peaking at about 3.4% in early March. But they are still hovering near 2.5%, and that suggests to Datatrek Research that the economy will avoid a worse-case outcome.
“Inflation always falls in a recession, often precipitously,” Nicolas Colas, the firm's co-founder, wrote in a Friday note. “This market is not going to see that any time soon.”
In credit, US investment-grade corporate bond spreads hit a five-month high, with the Bloomberg US Investment Grade Corporate Bond Index reaching 163 basis points on Wednesday. While this reflects growing concern about defaults, the spread peaked at over 600 during the global financial crisis and rose above 370 in the early days of the pandemic. While the spread has widened, it's trailing really narrow levels — and only in the US, said Sanford C. Bernstein strategists led by Sarah McCarthy. She said that it is hardly localized in Europe is a “reassuring sign” that these issues are “localised”.
TS Lombard strategists led by Andrea Ciccion wrote that rising interest rates have created an asset shortage, which now risks becoming a credit crunch. But unlike 2008, today exists what they call “self-stabilizing characteristics,” in which investor panic is driving up government bond prices and therefore reducing the size of the problem that caused the panic in the first place.
Stocks, as always, are sending a variety of signals, some of them very worrying, such as the selloff in bank stocks that has persisted even after the various bailouts rolled in. Worst volatility in the past year, as shown by top-down volatility. Whereas equity turbulence as measured by the CBOE Volatility Index jumped immediately above 30 in the days following the collapse of Lehman Brothers in 2008, and remained there for eight months, peaking above 80, it now sits at 25. It spent 2022 above 30.
There are few signs of excessive stress. The markets haven't really sold off, the frothy parts of the market remain resilient and the cyclicals are holding up well. Sure, the magnitude of volatility may increase, but all that volatility is “normal” across the various classes, said Dan Suzuki, deputy chief investment officer at Richard Bernstein Advisors, especially when the Federal Reserve begins such an aggressive rate-hike campaign. is operating.
The decline in banks and energy stocks directly bet that the economy will contract. But the equity story is full of nuance: Since panic over bank liquidity began last week, several industries have rallied. The Nasdaq 100 posted its best week against the S&P 500 since 2008 as investors flocked to large-cap technology stocks with larger balance sheets for shelter. Small caps tracked by the Russell 2000 index were down 2.6% in the past week, while the Stoxx Europe 600 fell 3.9%.
“In a crisis, all stocks will go down. So, instead of seeing Treasuries and big-tech stocks rallying together, we'll only see Treasuries rallying,” Male said. “In other words, if stocks like AAPL, MSFT, and NVDA rallied in a big way, It would be a sign that investors have shifted from looking for hiding places to looking for places to avoid losses.”
Within forex, the crisis has yet to flow for the US dollar, usually a safe haven for nervous investors. The Bloomberg Dollar Spot Index dropped 0.5% this week, while the strongest G-10 currencies included the Swedish krona and the Australian dollar, typically cyclically sensitive currencies.
All that said, the financial world is in a new era ever since central banks globally began tightening monetary policy to curb inflation. Lewis Gowdy Wilmaring, partner at Crewe Advisors, said the banking turmoil is collateral damage of cracks created in large part by the Fed, and it may take some time for sentiment to change. She expects volatility to increase in the coming months.
“We all just need to take a breath and see where things play out,” she said by phone. “But definitely the volatility is warranted.”
–With assistance from Katie Greifeld.
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