ACTV - If The Banking Crisis Is Over Rates Will Go Much Higher

2023-04-16 06:15:00 ET

Summary

• Earnings season has started and so far, the banks have delivered better-than-feared results.
• This has caused the market to start repricing the path of monetary policy.
• Rate cuts are being removed from the equation.

With signs of the banking crisis easing this past week, the market has started to reprice its bets on rate cuts. Bank earnings will play a big part in this, too, because they are coming better than feared, as deposits stabilize, there will be no reason for rate cuts in 2023.

JPMorgan ( JPM ) reported blowout numbers , and if a banking crisis is ongoing, it seems hard to find. Not only were JPMorgan's results strong, but so were Citigroup 's ( C ) and Wells Fargo 's ( WFC ). It could be that the banking crisis is now behind us, and it could even suggest that the expectation for financial conditions to tighten further may not materialize due to it.

At least based on the Fed balance sheet this week, usage of the Fed's discount window continues to subside, dropping to $67 billion from around $154 billion on March 15. Meanwhile, total loans by the Fed dropped to about $321 billion from a peak of $354 billion on March 22.

Furthermore, during this past week, there was a significant inflow of over $60 billion into bank deposits, marking its most substantial increase since the end of 2022. While one week's data may not be enough to confirm a trend or guarantee that inflows will persist, it is undoubtedly a step in the right direction.

Moreover, loans and leases experienced an increase this past week, marking the first time since the middle of March. Meanwhile, the Chicago Fed's adjusted national financial condition index indicated signs of easing this past week.

If there is a banking crisis, some of the pressures observed in previous weeks appear to be easing. If these conditions continue to improve, the market will likely adjust its expectations for the projected path of monetary policy. In light of the results reported by some of the large banks, the markets seemed to reconsider some of their prior assumptions regarding the path of monetary policy.

The likelihood of a 25 basis points rate increase for the May meeting also increased this past week to around 80%, up from 71% last week. The more signs of easing in the financial sector, the more probable it becomes that the Fed will continue raising rates.

This week, Fed Funds Futures increased from 4.48% to 4.57%, while the peak terminal rate increased to 5.06% in July. At the same time, the spread between the July 2023 contracts and the December 2023 contract has narrowed to just -49 basis points, an increase from its low of -71 basis points on March 24.

As the data indicates that the banking crisis is resolving and financial conditions are easing, the spread is more likely to contract further as the market moves to remove rate cuts from its forecast for 2023. Removing rate cuts will increase interest rates along the Treasury curve, leading to higher real yields.

The equity market's upward movement has been mainly due to the expectation that the Fed would cease raising rates because the stress from the bank sector would result in financial conditions tightening, doing some of the Fed's work. However, if this assumption proves to be incorrect, and the banking crisis continues to ease, it is likely to force the Fed back into action until there are clear indications that not only are the sticky components of inflation easing but that the labor market is cooling.

Up to this point, sticky inflation remains high, as indicated by the Atlanta Fed's 12-month Sticky CPI, which remains at 6.45% in March, down from its December peak of 6.61%.

So not only will future economic data help shape expectations for monetary policy but earnings season will also. If the banks show signs that they are doing rather well, the impact of the banking crisis are easing, and the borrowings from the Fed and bank deposits stabilize, one would think that rates will go higher as rate cuts are moved from the equation for 2023.

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