The last time the market was so volatile was in the 1980s. Moves of this magnitude are exceptionally rare. The ongoing tremors in the banking sector have led to sharp swings in Treasury yields, with the 2-year Treasury moving more than 20 basis points (bps) in a day, mostly to the downside, on nine separate occasions over the last 60 days. Fixed income – downward pressure on yields economy adding 253k jobs in April), healthy consumer spending will likely buoy any weakness in business investment. Until a significant slowdown in the labor market occurs, which has not yet occurred (evidenced by the U.S. Why? Because consumer spending makes up ~70% of GDP and is generally the main driver of the trajectory of the economy. The consumer remains in the driver’s seat | While tightening lending standards and a potential slowdown in small business activity potentially pose headwinds for economic growth going forward, we do not want to overestimate its impact. As small businesses make up ~48% of total employment and generate ~44% of total economic activity, a slowdown in small businesses will be a headwind for economic growth going forward. It is not surprising that the net respondents in the NFIB Small Business Optimism Index reported easier availability of loans declined to the lowest level (-9%) since 2012 and only 2% saw now as a good time to expand, the lowest level since the Great Financial Crisis. As a result, the regional banking turmoil will disproportionally hamper smaller businesses. Small businesses hit | Relative to larger businesses, small businesses rely heavily on regional and smaller banks rather than larger banks (>$250 bn in assets) for financing. In particular, small/medium sized banks have likely tightened their lending standards which in turn will weigh on both small business borrowing and investment going forward. On May 8, updated figures from the Fed’s Senior Loan Officer Survey for 1Q will be released and likely show the trend of further tightening in lending standards. In fact, at the end of the first quarter, it was noted that a net 45% of banks had reported tightening lending standards, up from -15% (suggesting easing lending standards) just one year ago. Impact on lending | As a result of the Fed tightening cycle – 10 consecutive meetings of increasing the Fed funds rate – and rising borrowing costs from credit cards to auto loans, lending standards had already been tightening leading into this recent banking turmoil. But the recent turmoil in regional banks, caused primarily by poor strategy and risk management, will likely have a bigger impact on business lending than on the consumer. Tighter lending standards by the Federal Reserve (Fed) were expected to cool the economy and take the edge off inflationary pressures – which it has. Economy – not on the edge quite yetĪ healthy banking system is important to the growth of the economy, and, fortunately, the recent turmoil has not yet reached a level that would cause us to significantly change our economic forecasts. While headlines of bank failures are unsettling for investors, it’s important to put the recent bout of banking sector volatility into perspective and consider what it means for the economy and asset classes. Volatility in the regional banking sector is likely to continue into the near future. While the S&P 500 has been largely flat over this time period, the KBW Regional Banking Index has plummeted and is now down 61% year-to-date, sitting at a three-year low. Over the past two weeks, the regional banking turmoil has reemerged as First Republic Bank failed and was ultimately sold to JP Morgan, shares of other smaller regional banks like PacWest and Western Alliance fell demonstrably, and the merger between TD Bank and First Horizon was surprisingly scuttled. To read the full article, see the Thoughts on the Market publication linked below. With regional bank volatility grabbing headlines, CIO Larry Adam looks at what this activity means for the economy and asset classes.
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