Investors flocked to safe-haven assets this morning in response to Deutsche Bank, which sparked renewed jitters about banking instability, while fears about both the U.S. economy and corporate earnings strengthened.
Shares of Deutsche Bank dropped more than 14% in response to the price of credit default swaps jumping from 142 basis points (bps) to more than 173 bps overnight. Credit default swaps serve to protect the bank’s bond holders from a possible default. The increased costs of default protection sent Deutsche shares down for the third consecutive day, resulting in the securities losing nearly a fifth of their value. The turmoil occurred despite European Central Bank (ECB) leader Christine Lagarde’s comments that European banks have strong capital and liquidity, but if issues arise, the ECB is prepared to provide liquidity.
Concerns about Deutsche Bank intensified existing banking fears, causing equities for U.S. regional banks such as PacWest Bancorp, Western Alliance Bancorp and KeyCorp to drop at least 3% during morning trading before recovering. Shares of First Republic Bank, which is in the process of being shored up by a group of banks under the leadership of JP Morgan Chase CEO Jamie Dimon, fell more than 6%. The banking turmoil occurs as UBS is acquiring failed Credit Suisse, and U.S. regulators are assessing the failures of Silicon Valley Bank and Signature Bank.
Bond yields are continuing to plunge led by expectations that the Fed is done hiking. Odds are favoring rate cuts as early as June, as the disinflationary effects of credit contagion stall economic activity.
Bond yields are continuing to plunge led by expectations that the Fed is done hiking. Odds are favoring rate cuts as early as June, as the disinflationary effects of credit contagion stall economic activity. The 2-year Treasury yield is down 10 bps and is roughly 140 bps lower than its cycle high reached earlier this month. The Dollar Index is up 0.6%, however, as trouble at European banks pull the euro down 0.7% versus the dollar. Banking contagion fears are also weighing on oil demand forecasts and the inflationary outlook, bringing WTI crude oil down 2% to $68.56 per barrel and the 10-year Treasury yield down 5 bps to 3.35%. The S&P 500 Index is down 0.2% after being down 1% earlier in the session.
Investors today are also assessing new data showing the manufacturing sector is continuing to weaken as higher rates take their toll. Durable goods orders fell 1% in February versus the 0.6% growth expected by analysts, a slower rate of decline relative to January’s -5%, however. Transportation equipment weighed on the headline figure with defense and nondefense aircrafts notching significant declines in orders of 11.6% and 6.6%. Computer and automobile orders also weighed on results, falling 2.7% and 0.9% during the period. Core capital goods orders offset some weakness, gaining 0.2% on the month and slowing from the 0.3% rate of growth experienced in January.
Today’s Flash PMI data from S&P Global reflect further March weakness, with the manufacturing sector remaining in contraction territory for the fifth consecutive month. March’s reading of 49.3 was a five-month high, however, as the rate of decline in the manufacturing sector is slowing. The service sector, however, remained red hot, reaching an 11-month high of 53.8. Demand for services and for employees remained strong, driving continued price pressure in the sector. Flash PMIs for both manufacturing and services beat consensus expectations handsomely, with analysts expecting 47 for the former and 50.5 for the latter.
Investors are also grappling with anticipated declines in U.S. corporate earnings as higher interest rates dampen economic activity. At the end of 2022, analysts expected first quarter year-over-year earnings to decline 0.3%. However, the earnings picture has worsened significantly and as of late last week, analysts expected first quarter earnings to decline 6.1%, according to FactSet. The 6.1% decline would be the largest decline since the second quarter of 2020 when the Covid-19 pandemic was at its depth. Materials, Health Care, Communication Services, and Information Technology sectors are expected to experience the largest earnings declines while Consumer Discretionary, Industrials and Energy sectors are expected to have the largest gains. Earnings are also expected to decline in the second quarter, but turn positive in the third quarter–a rosy outlook that will likely fail to materialize if a recession arrives in the second half of the year.
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