Markets were reacting nicely Thursday to a small increase in jobless claims and then got dragged down by two big things: renewed focus on the debt ceiling and a particular bank. Let's work out what happened -- and what continues to unfold Friday.
Friday's job report should be good for bonds, and ultimately markets. The headline number was strong: 311,000 versus expectations of 225,000 and revisions were "only" down 34,000.
But at the same time, we have that half-percentage point threat hanging over us. What would get the Fed to lean toward a quarter percentage point? I saw a few things in the jobs report. Average hourly earnings came in at 0.2%, which is consistent with other data highlighting that wage growth is slowing. Also, weekly hours worked dropped from 34.7 (revised down to 34.6) and were at 34.5. Hours worked is often a leading signal about future employment needs, so that number moderating is good for not having to hike aggressively. Finally, the unemployment rate popped to 3.6% from 3.4%, partly due to weaker Household report, an uptick in labor participation rate (really good news, as it alleviates labor market pressure without forcing job losses) and probably some rounding.
Normally, on the non-farm payrolls, we could be "done and dusted" for the day after this report, and watch markets react, but there is more going on.
Bumping the Debt Ceiling
President Joe Biden released his "budget talking points." Although virtually everyone instantaneously agreed it is "dead on arrival," it bumped into the markets. The starting point isn't compromise or "reaching across the aisle." It is setting up camp as far away from the other side as possible and digging in. Waiting for the battle to begin. I almost never look at sovereign credit default swaps, at least not for major countries, but the U.S. credit default swaps' spread is widening (it is still tiny). I presume, that there is some sort of "cheapest to deliver" trade around a technical default, but now I should actually read that (so much for fun weekend plans).
In any case, while we thought the debt ceiling would be more disruptive, by far, than previous episodes, I thought we had some time. We might not.
To make it easy on compliance, I won't mention any institutions by name (that will be in the weekend report), but off-hand I think recent events are more isolated than indicative of a broader existential problem. Let's list them:
Bank Existential Problem: I see nothing that is a threat to the broad banking system on an existential level.
Problems for all Banks: Having to raise deposit rates as investors are "suddenly" fixated on yields -- they are so fixated that we felt compelled to write about 2-year yields. That is an earnings issue, but by no means existential threat.
Commercial Real Estate: One area I cannot help but keep an eye on, as we see how successful (or not) work from office is, vs. work from home, is the commercial real estate market. I think there could be some issues - but only in some pockets and regions.
Unique or "Self-Made" Problems: We could have a highly concentrated and correlated depositor base. When the source of money comes from very similar clients, you are very susceptible if those clients have problems. I'm not just talking about the individuals, but the companies. Also, we have to deal with cash flow burn, without replenishment has hit the "disruptive" community hard. When your borrowers look like your depositors, that's also a concern. If there is a lot of overlap between who was being lent to and who was depositing money, then we have to look at that. Nothing goes pear-shaped more quickly than lending to someone who has to drain their deposits to keep afloat until they no longer have deposits and need the loan restructured. I cannot say this has happened, but a lot of things are pointing that direction. Finally, What likely started as "normal course of business," needing to reduce their deposits likely put pressure on the bank in question and started the cycle of liquidation, bad stories, etc. Only then did it morph to people in general, deciding there might be better places to stash my cash.
FUD Fun: Fear, Uncertainty and Doubt
Many in the crypto community, with hundreds of thousands of followers, seem to be feeding disinformation to an eager community. I've seen well-read reports discussing banks leveraging 10-year Treasuries against their deposit base. I think that would be extremely difficult to do under current regulations, but goes against what I've seen from most banks (taking credit risk while carefully managing interest rate risk).
Also, we have little discussion about bank stress tests. I didn't expect these to be as well designed and as thorough as they became. No, you cannot rely on them completely, but too little is being discussed about this.
The crypto community would like this to be a "banking" story, because that would push people to crypto, but in reality, it looks like it is just the usual story, about an individual institution or two (there is one named after a precious metal) that got in over their skis. Almost every year, some banks get into trouble and some eventually default, and the market usually yawns. The current situation is attracting far more attention than usual, and I'm not certain why. There is of course an entire cottage industry out there predicting the next financial crisis and they have something new to sink their teeth into (more often than not, it has been the "imminent" default of BBB bonds that has attracted their attention).
On a standalone basis, non-farm payrolls should help stocks and bonds. Debt ceiling will hurt stocks, but that can go back to the background. The hit to banks seems overdone, and I'm looking at the case to overweight banks in stocks and credit.