Show me the money

By: Patrick O’Toole, Adam Ditkofsky and Pablo Martinez

Economic data

The SVB debacle may ultimately prove to be the catalyst that proves the old axiom that “The Fed tightens until something breaks”, leading to a broad-based slowdown in the economy and pain for financial markets. It remains to be seen, but it certainly has been a catalyst for a massive shift of money from banks to certificates of deposit (CDs) (in the U.S.) and money market mutual funds. It took a while for depositors to realize that they could get more than 0.1% on their deposits, but once they started to see over 4% on T-bills and CDs, the money started to flow FAST. That remains a concern for banks and the broader economy, given that small/regional U.S. banks are responsible for a huge amount of funding for businesses. Less ability to lend = less GDP. So the concern is real. And even if the banks start to offer depositors more than 4%, the banks’ net interest margins take a hit. Lots of moving parts … and they haven’t stopped moving yet. Even Jamie Dimon cited the SVB debacle as something that will have an impact for years. Who knows? It may be the catalyst for a flurry of M&A activity that ultimately ends up with big banks getting much bigger, and fewer small/regional banks, and ultimately looking more like the Canadian banking system. 

There were other signs this week that growth is poised to slow. One of Fed Chair Powell’s favoured labour market indicators is the JOLTS (Job Openings and Labor Turnover Survey) indicator that fell below the 10 million mark for the first time since May 2021. It’s a sign that the job market is cooling, although the number of jobs available for each unemployed worker remains well above the level the Fed would like to see. The survey of manufacturers (ISM manufacturing) also pointed to a weak outlook, as this diffusion index fell to a 34-month low, and has been below the expansion/contraction marker of 50 for the past five months. The survey of services managers, while above the 50 level, fell more than expected, with the sub-components of prices paid, employment, and new orders also dipping. The resiliency of the services sector has been a major concern of the Fed, so this news gives the Fed some backing to pause at its May 3 meeting. In fact, the futures markets now see only about a 40% chance of a hike of 0.25%, down from almost 60% odds last Friday. Not even OPEC’s surprise announcement of production cuts that raise concerns about a reacceleration of inflation could dissuade investors from downgrading the odds of more hikes. So, we’re increasingly likely to see the Fed follow in the Bank of Canada’s footsteps by putting a halt to its rate hike program.  

In Canada, we had evidence from the Bank of Canada’s survey of businesses that the pause in its rate hike program was justified. Conditions turned negative for the first time since September 2020, with labour shortages easing and price expectations dipping. The labour market remains buoyant, however, as seen by today’s employment report that showed more new jobs than expected and wages dipping a bit year/year. 

Bond market reaction

The pattern of extreme volatility in the bond market continued this week. The U.S. 2-year Treasury bond’s yield, which is usually a good proxy for where Fed Funds will settle, was over 5% on March 8, and is now well below 4%. That’s telling us the market believes hikes are done, and cuts are coming. The latter may be premature, given the Fed has generally cut rates, on average, about 7 months after its last hike, and the futures market currently sees cuts coming by July. The rally in the 2-year area has been followed further out the curve as yields moved lower on the week, and remain well below the Bank and Fed rates. Investment grade corporate spreads were little changed on the week, although the high yield sector saw spreads move higher on the week as the S&P lost some ground.  

Stock market reaction

Equity markets kicked off the week with a bang following the surprise oil production cut from OPEC+. The unexpected move sent oil prices back above $80 per barrel, offsetting weaker demand concerns, and lifting the resource heavy S&P/TSX. Teck Resources, soon to be Teck Metals, had the biggest move on the TSX following the announcement that it was rejecting a bid by Glencore to combine companies into a copper and coal powerhouse. It is currently management’s stance that it will be able to maximize the value of the company by proceeding with their scheduled carve out of their coal business and the sunset of their dual-class shares set for a vote later this month. First quarter earnings kick off in the U.S. next week, with much attention being focused on earnings outlook versus consensus expectations, and whether or not current valuation multiples are justified by the less-rosy earnings outlook. The recent move higher for the S&P/500 has lifted that index above its long-term average valuation, while the S&P/TSX remains well below its historic valuation levels. 

What to watch next week

The Bank of Canada meets next week and no change in the policy rate is expected. We’ll also see some housing data, while the U.S. sees the release of the employment report tomorrow, with inflation, producer prices, and retail sales next week. 

Patrick O’Toole is Senior Portfolio Manager, Global Fixed Income

Adam Ditkofsky is Senior Portfolio Manager, Global Fixed Income

Pablo Martinez is Portfolio Manager, Global Fixed Income.

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