March was quite a month for the bond market, which is saying something given everything else that grabbed headlines during the month that was.
It began with the 10-year Treasury yield pushing pass 4.0% and ended with it back down to 3.48%. In between came a banking crisis, a modest decline in inflationary pressures, an “historic” rally in bonds (Wall Street Journal, March 13), and a further 25 basis point rise in the Federal Funds rate. Yields on the two-year topped 5.0% early in March for the first time since 2007 then posted the biggest three-day decline since 1987 to end the month at 4.58% (CNBC, March 31).
Stocks went along for the ride, falling sharply in the wake of the March 10 collapse of Silicon Valley Bank and then rallying (Wall Street Journal, March 10). The net of all that volatility was a 3.5% rise in the S&P 500 and 6.69% jump in the Nasdaq for the month. The Dow was the laggard, comparatively up “just” 1.89%.
All about the banks
The banking sector provided yet another lesson, if one were needed, in the law of unintended consequences. Following the 2008 Financial Crisis, regulators focused on credit quality; the current troubles have been driven mostly by something else: liquidity, and a duration mismatch between bank assets and liabilities triggered in part by Federal Reserve policies that took the Fed Funds rate from close to zero to 5.0% over a 12-month period.
Silicon Valley Bank was not the only casualty. New York’s Signature Bank also collapsed and First Republic Bank saw its shares plummet (Wall Street Journal, March 17), while outside the U.S., a struggling Credit Suisse was taken over by UBS. In the midst of the crisis, speculation grew that the Fed might back off lifting rates again at its March meeting, but that was not to be as the Fed stayed laser focused on inflation concerns. While there was a nod in the direction of the crisis in Chairman Powell’s press conference remarks, up rates went again by another 25 basis points.
The inflation data itself was generally positive. The March read on the Personal Consumption Expenditures (PCE) Index (for February) saw a month-to-month rise of 0.3% excluding food and energy (BEA, March 31), compared to a rise of 0.6% in January (BEA, February 24). Year over year, the PCE was up 5.0% annually compared to 5.4% in January. Weighing against this was a continued strong employment market, with the March report seeing 311,000 new jobs added (New York Times, March 10), topping expectations. The unemployment rate rose to 3.6% from 3.4% the month before.
Investors looking for a place to hide increasingly returned to tech stocks and piled into money market funds (Wall Street Journal, April 1). At quarter’s end (March 31) the Nasdaq was up 17.0% with Apple and Microsoft dominating (Wall Street Journal, March 22), while the yield on the average money market fund stood at 4.6%, according to Crane Data, up from 0.02% at the start of 2022. Money market funds added a net $283 billion in March, according to Refinitiv. Gold, too, had its fans, as it will in times of turbulence, with prices reaching $2,000 an ounce for the first time since Russia invaded Ukraine a year ago (Wall Street Journal, March 29).
Next rate move
With banks continuing to weigh on the markets – and the still all too real possibility that what’s been happening in banking will spill over into the broader economy – speculation has been growing that the next move in interest rates will be down. Derivatives traders were pricing in a peak federal funds rate of 4.9%, below the Fed’s own expectations of 5.1%, and expected rates to fall to 4.4% by year end, according to The Wall Street Journal, citing FactSet data (Wall Street Journal, March 31).
Recession predictions have so far been the Zeno’s Paradox of this economic cycle – always getting closer, never arriving. A Bloomberg survey of economists found that the probability of a recession next year had gone from 60% in February to 65% in March. How that plays out remains to be seen and there is plenty of time for new forecasts between now and then.
A volatile March exited the stage on a lion-like note. On the month’s last trading day, the S&P 500 tacked on another 1.4% while the Nasdaq added 2.7%, powered by the tech stock rally (Bloomberg, March 31). But the excitement may not be over yet, as the banking crisis continues to reverberate around the markets and around the world. Reflecting this, one Bloomberg story noted that the gap between the highest and lowest year-end targets for the S&P 500 recently stood at 47%, the widest at this time of year in two decades (Bloomberg, March 29).
All to say, there is a lot of hedging going on, both among investors and pundits. Almost certainly there is more excitement, and more volatility, yet to come.