Markets are responding dramatically to a confluence of headwinds this morning, including Treasurer Janet Yellen’s announcement of a sooner-than-expected debt ceiling deadline of June 1, which propelled fears of higher yields, possible credit downgrades and financial market instability. This morning’s Job Openings and Labor Turnover report, which came in below expectations but still depicted a tight labor market, and news of additional regional bank issues—just a day after failed First Republic Bank was snatched up by JPMorgan— sent additional shockwaves through markets as investors anxiously await an expected 25-basis points rate hike from the Fed.
Prior to the Yellen announcement, the equity market was priced for perfection at roughly 19 times forward earnings and on balance investors, but not economists, were anticipating earnings growth later this year. I call it the economist-strategist mismatch, as economists see a second half recession for the economy while strategists anticipate earnings rising in the second half of this year. The mismatch is stimulated through a disconnect in fed rate expectations, with the market pricing in fed rate cuts in the second half of the year while the Fed has declined to promote that line of thinking.
Meanwhile, the regional bank debacle continues. Earlier this morning, trading of PacWest and Western Alliance shares was halted, with prices for both stocks declining approximately 25% and pulling the KBW Nasdaq Bank Index down 7%. The banks had reported double-digit drops in their deposits at the end of March and PacWest said it is exploring the sale of assets to provide liquidity. Later this month, the FDIC updates its problem bank list for the first quarter, which is likely to move significantly higher because at the end of 2022, there were only 39 banks on the list with a combined asset value of $47.5 billion.
A failure between Democrats and Republicans in Congress to agree on debt-ceiling matters will almost certainly pull equities much lower amidst an environment with a plethora of other risks (elevated valuations, recession, earnings contraction, geopolitics, Fed overtightening, credit access constraints).
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