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May 8, 2023 - Confusing markets call for cautious steps.

Financial markets are currently pricing completely different scenarios than the data or the central banks are telling us. The US bond market has clearly priced in interest rate cuts as soon as the last three months of the year, betting that a recession will force the FED to do so, rather sooner than later. The equity market, on the other hand, is trading at valuations not in line with a recession coming. We have to note that the 4-5 large Technology companies with a big weight in the US indices skew the picture, and underneath the gains of the S&P500 a lot of negative performance is masked. Against the bond market's expectations for rate cuts, the FED confirmed that it will probably pause its hiking campaign, but hinted that it does not see any rate cuts this year. And the bond market chose not to listen and moved even higher (in prices, and lower yields). The ECB was adamant that more interest rates are coming, but the EUR bond market rallied after the announcements in anticipation of a pause and rate cuts too in the Eurozone. And Eurozone equities are at multi-month highs, having risen more than 10% this year and valued at levels not compliant with a potential recession, that the bond market has decided to price in. Does all that sound confusing ? The answer is a simple yes, even for professional investors like ourselves.

The banking crisis in the US is far from over, as a fourth bank looks to be in trouble. Shares of a small regional bank, Pacwest Bankcorp, fell more than 60% during last week, although they recovered some ground on Friday, as the market is betting that it will be the fourth bank to be taken into receivership by the FDIC. Other regional banks' shares also fell during the week, as the market remains very fragile.

The FED raised rates by 0.25% to 5.25% and hinted for a pause. The statement of the announcement had similarities with the text of a meeting in 2006, which turned out to be the last hike, back then. We can probably assume that they "copied-pasted" it, in order to convey the message. In the press conference Chairman Powell reiterated the FOMC statement language, saying that the "extent" and "timing" of more monetary policy tightening depended on incoming information, a meeting-by-meeting decision. The tone sounded comfortable with potentially pausing, but we have to note that the door for more rate hikes was left open. Credit tightening remains a concern, and could do the work of rate hikes, without raising rates, he said, and that answer added to the sense that this may be the last rate hike.

The ECB raised rates by 25bps, as widely expected, but maintained its hawkish tone. One day after the message by the FED that the hiking cycle is entering a new phase of "pause and reflect", Mrs. Lagarde wanted to make sure that this is not the case in the Eurozone. She repeatedly mentioned the phrase "we are not pausing" during her press conference and now the market expects two more rate hikes in June and July. The terminal rate is now looking to be closer to 3.75%, from 3.25% after last week's hike.

Eurozone Core inflation slightly dropped in April. The decline in Core to 5.6% from 5.7%, the first since June 2022, is certainly a step in the right direction. The drop was solely driven by the second consecutive decline in goods inflation (-0.4% to 6.2% y/y, a five month-low), building on earlier indications that the easing in supply bottlenecks and falling energy prices have started to feed through to final products. In contrast, services inflation rose further (+0.1pp to 5.2% y/y), an unsurprising outcome in the context of rising wage growth. In summary, while services inflation rose further, goods inflation stabilised. The headline number is still at 7% however, with the recent fall in enery prices to drive inflation lower, probably next month.

The latest US labor market data showed decent growth, but the trend is still deteriorating. The April non-farm payrolls were announced at 253'000, much better than the expectations of 180'000 and unemployment fell to a new low of 3.4%. Average wages rose by 0.5% on a monthly basis, a little higher than expected, and 4.4% on an annual basis. For now, the massive layoffs that have been announced by various companies and primarily in the Technology sector have not affected the monthly data and the overall unemployment figure. However the weekly jobless claims have been rising and now stand at a higher level than in 2019, per-pandemic that is.

Equities finished on a mixed tone, but a Friday-rally saved the week from worse. The S&P500 and the Dow Jones fell almost 1%, despite a 1.5% rally on Friday, but Nasdaq closed the week with small gains (+0.1%). In Europe, Swiss stocks rose by 1%, while France and the UK fell by almost 1%. In terms of sectors, Energy continued its recent free fall with a 4% weekly drop followed by Financials (-1.5%). Heathcare and Technology rose by about 0.5% on average.

Bonds rallied and then fell after the labor market data. As mentioned in the first paragraph, bonds had been moving higher for most of the week as the market was focused on a possible recession and the troubles hitting yet another bank. The US 2-year yield reached a low of 3.70%, but rose to 3.90% on Friday, as the equity market recovered and the labor market data were better than expected. The US 10-year is trading close to 3.40%. The German yields also moved lower (prices higher) despite the ECB warning for more rate increases. The 2-year yield is at 2.55% and the 10-year at 2.30%.

In corporate earnings news : Apple posted solid revenues and higher-than-expected profits, helped by the growth of sales in China. Still however, its quarterly sales are down compared to last year. AMD posted good results but provided weak guidance for the next quarter, blaming the weak PC market for semiconductors. Warren Buffet's Berkshire Hathaway reduced the exposure in US stocks by 14bn$ in the first quarter, raising its cash to the highest level of the last two years. Its stake in Chevron which was cut, attributes about 6bn$ of this reduction.

Chart of the Week : Can history repeat itself ?

As already mentioned above, the text of last week's FED announcement contained a phrase which echoed the language introduced at the June 2006 FOMC meeting, which turned out to be the last hike of that cycle. We do not think that this was a coincidence, because the FED wanted to pass that message with a text already known to the market of what it means. In the above chart we take a closer look at the history of the FED rates in the last 20 years and we want to focus on the 2006-2008 period, which is what the FED chose to do. The first observation we would like to highlight is that although rates stopped moving higher in the summer of 2006, they remained at the same (high) levels for almost one year, until the summer of 2007. Secondly, the rate hikes of 2004-2006 spanned over three years while this time the FED raised interest rates close to the same levels but within only a few months, in a "fast-forward" mode. Back then, a almost one and a half years from the last hike, a banking crisis erupted, which started in March 2008 (Bear Stearns collapse) and culminated to the Lehamn Brothers collapse in October . This time around we have a small banking crisis fire burning in the US which by coincidence it started also in March, with SVB and Credit Suisse, but started almost immediately after the aggressive interest rate increases (again in a "fast-forward" mode). We do not want to extrapolate further this point, as a similar financial crisis like 2008 is not our base-case scenario. But then again, one must proceed with extreme cautiousness in today's environment for a few more months, as similarities are striking with that period even if everything happens much faster today than then.


• The content of this document has been produced from publicly available information as well as from internal research and rigorous efforts have been made to verify the accuracy and reasonableness of the hypotheses used. Although unlikely, omissions or errors might however happen.

• The data included in this document are based on past performances and do not constitute an indicator or a guarantee of future performances. Performances are not constant over time and can be positive or negative.

• This document is intended for informational purposes only and should not be construed as an offer or solicitation for the purchase or sale of any financial instrument and it should not be considered as investment advice. The market valuations, views, and calculations contained herein are estimates only and are subject to change without notice. Any investment decision needs to be discussed with your advisor and cannot be based only on this document.

• This document is strictly confidential and should not be distributed further without the explicit consent of Kendra Securities House SA.

• Sources: Chart of the Week : Factset


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