Crisis? What Banking Crisis?

The Interactive Brokers’ team discusses the aftermath of the banking crisis and the onset of earnings for the nation’s banks, along with the usual review of labor and inflation data.

Summary – IBKR Podcasts Ep. 69

The following is a summary of a live audio recording and may contain errors in spelling or grammar. Although IBKR has edited for clarity no material changes have been made.

Andrew Wilkinson

Welcome everybody to this week’s Interactive Brokers’ podcast. I’m Andrew Wilkinson, director of trading education. I’m joined by my colleague, Steve Sosnick, who is our chief strategist and senior economist, Jose Torres. Welcome, gentlemen.

It’s great to have you back. We’ve got a lot to talk about. Let’s get straight into it. Jose, last week we had the March employment data and somewhat of a softening; the private ADP reading showed a decline in employment from 261,000 to 145,000. And then the official government reading from the BLS showed a softening from 326,000 to 236,000. We’ve still got an unemployment rate very near the historic lows of 3 1/2%. We’ve also got this week’s consumer price report due midweek. Inflation looks like it’s heading from 6% down to 5%. How critical is that in the context of the Fed’s job ahead?

Jose Torres

Great question. Let me start off with jobs. The discrepancy is a lot narrower when you take out government employment from the BLS, which was a big boost for March employment. Private sector employment slowed significantly. When you look at some of the cyclical areas, like manufacturing construction and retail, those [sectors] all lost jobs in March. When we look at the ADP report, without the contribution from small and mid-sized firms, we actually would have lost jobs because large companies trimmed a lot of labor.

As far as the unemployment rate, we’re starting to see folks come back into the labor force. We’re seeing the labor force participation increase. Historically speaking, the unemployment rate tends to be very low immediately prior to recession and I think that’s where we’re going consistent with the 2023 economic outlook that we released in late December. As far as consumer prices, the report this week will show some relief in the overall categories particularly because oil prices softened in March. However, the services category is still extremely problematic. In fact, when we look at the jobs report, the leisure and hospitality [sector] was the big gainer in both the ADP and BLS jobs reports. While they’re not spending on big ticket items, durable goods like furniture, refrigerators, stuff like that, or vehicles, they are spending on experiences. A lot of that is due to the pent-up demand from COVID and that area.

Leisure and hospitality continue to have big labor shortages. They tend to be lower paid. Folks aren’t as ecstatic to go into work in that sector, and that’s driving a lot of the services inflation. I think that this CPI report will be cheered by the market. But I think that the one we receive next month due to oil prices, we have our in-house models here showing that the April inflation report, which comes out in May, is going to be particularly hot. As far as the Fed, we have seen a monetary policy juxtaposition in March where they’ve essentially put out the fire in the banking sector by raising their balance sheet and providing liquidity, but at the same time still providing guidance that they’re going to be increasing rates. So that’s looser on one side. It’s tighter on the other, I am of the bias that they’re going to go higher for longer.

Andrew Wilkinson

Very good. So, Steve, last time we sat down a month ago, there was a banking crisis going on.

Steve Sosnick

OK, there still is.

Andrew Wilkinson

What banking crisis? It doesn’t feel like there is one right now.

Steve Sosnick

It’s always difficult to say. Nobody rings a bell and says the crisis is over. You don’t get that. The first thing, the first banks that went down were what I would consider the weakest sisters. You can point to something with each of them. Signature Bank was crypto related. It’s pretty clear what’s happened to crypto. I’m sorry Silvergate was the first, Silvergate was crypto (SI). Signature Bank (SBNYQ) was also crypto and they had a penchant for being involved in sort of all the weirdest corners of New York area finance; taxi medallions, lending to real estate companies that were otherwise shunned, that sort of thing. SVB (SIVBQ) was a very unique situation, and Credit Suisse (CS) has been problematic for years, certainly since the Archegos debacle.

This is what you get when you have interest rates rising and it’s a bit of a culling of the herd. SVB pointed out the classic duration mismatch, which is, banks have always tended to borrow short and lend long. They did it in extremis on both sides and it handcuffed them to a point where they couldn’t recover. I think right now you’re seeing a lot of machinations among various banks and among various depositors trying to reassess things. And as you get those kinds of readjustments throughout a large segment of the banking system, it’s too early to say you won’t see something else. But I cannot tell you what it will be, and I certainly hope there won’t be.

Andrew Wilkinson

And we have financials kicking off earnings season this week. I think what you’re saying is it’s too early to tell, but will learn anything from that?

Steve Sosnick

I think so, and I hope so. It’s funny because I’m on record various times saying I hate the fact that banks lead off earnings season. They’re typically a terrible harbinger for what’s to come because their business is so unique and really the only thing they tell you about earnings season in a normal year is what their customers are saying and what their CEO’s tell you their customers are saying to their bankers. This year is quite the opposite because I think so many eyes are focused on the banks. I think what you get first are the big tier, the money center banks as they were. They’re getting lots of inflows of very, very cheap money. They pay almost nothing on their deposits. But, you know, that’s the flight to safety, so to speak. And I think it’ll be interesting to see how there’s the sequencing between the the money center banks, the JP Morgans, the Citis that go first. And then the following few days into the next week are the mid-tier banks and where their money is going and what they’re telling us. I have a feeling the second, the latter part, will be a little more interesting because quite frankly, the money center banks have a nice business. If they want to pay you a basis point on your deposits and then go out and lend it to the Fed for 480 [basis points], that kind of works for them.

Andrew Wilkinson

Jose, are we more or less likely to land in recession as a result of the banking crisis? What’s your opinion?

Jose Torres

More likely. Recent data show that lending is down significantly on a percent change basis. It’s down lower than during the great financial crisis. Deposit outflows also [are] down significantly to levels that we haven’t seen in decades. Taken together, like Steve said, that leads to the cost of funds for regional banks to increase as they try to perhaps drive more deposit inflows, while at the same time because lending is falling, they don’t have the same yield opportunities, right. So that essentially leads to earnings being subdued. The banking sector rather continuing to be in consolidation, a lot of mergers, a lot of acquisitions. More failures this year in terms of recession. This is occurring at the same time that consumers are becoming exhausted. Prices are still rising. They are rising at a slower pace, but they are still rising at a time when employment opportunities are starting to soften significantly. Like we said earlier, job openings have been coming down pretty quickly. Initial unemployment claims have been rising pretty quickly, not at an alarming level yet, but again, it’s a delta kind of analysis there. That’s worrisome. And I think overall the credit crunch and the consumer slowing down at the same time leads us to recession in the second half.

Andrew Wilkinson

And Steve, what’s the bond market telling us?

Steve Sosnick

The bond market is telling us that they fear recession, it’s very clear. I think the real question for equity investors and as well bond investors is what is the pace of Fed tightening and the pace of the inflation fight. I’m imagining, and let’s say, maybe not even the May Fed meeting, but the June meeting or even the subsequent ones to that, at what point is the Fed going to look at each other and say, “You know what, we’ve whipped inflation here. Let’s just start cutting rates”. They’re not, I don’t see that happening. They are about stable prices and full employment. It’s clear from the last employment report that maybe things are not as robust as they were, but they’re still pretty full. So, we have an unemployment rate of 3 1/2%. Are they are going to just start cutting the rates because we go to 3.8%, because we go to 4%? You can argue full employment — and just give me a yes or no, Jose, because we’re running low on time — full employment is probably somewhere closer to four, typically somewhere in the 4 1/2 percent range?

Jose Torres

Correct, yes.

Steve Sosnick

I think the bond market is way ahead of the Fed, certainly ahead of the Fed rhetoric. But I think ahead of the Fed logic and that to me is the real economic question that we’re going to be wrestling with for the weeks and months going forward.

Andrew Wilkinson

Steve Sosnick, Jose Torres, thank you very much indeed for joining me today. And don’t forget folks, please visit ibkrcampus.com for all your financial news, commentary and learning needs and look out for more additional audio commentaries at ibkrpodcasts.com.