Here are the main factors driving the ASX this week according to Pendal portfolio manager JULIA FORREST. Reported by portfolio specialist Chris Adams.

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THE odds of a 50bp US rate hike next week increased markedly after hawkish comments by Fed chair Jay Powell – but that didn’t last long.

Powell last week told US Congress that if the data indicated faster tightening was warranted, “we would be prepared to increase the pace of rate hikes”.

Stronger-than-expected data suggested “the ultimate level of interest rates is likely to be higher than previously anticipated”, he said.

The comments drove two-year US Treasury yields above 5% for the first time since 2007.

The spread between two-year and 10-year bond yields inverted to -107bp – the biggest inversion since 1980 when then Fed chair Paul Volcker was trying to kill inflation.

However, all this was reversed after the collapse of Silicon Valley Bank (SVB) late in the week, which saw yields fall.

Market expectations for next Wednesday’s decision quickly dropped back to a 25bp hike.

Equities continued to sell off. The S&P 500 fell 4.5% and the S&P/ASX 300 shed 1.2%.

US labour markets and SVB

On Friday we saw a strong US payrolls number with 311,000 additional jobs versus 225,000 expected.

This followed a very strong January number.

February average hourly earnings were up 0.2% M/M and +4.6% Y/Y, slightly below consensus (+4.7%).

In normal circumstances the labour numbers would have realised the Fed’s worst fears about labour market resilience – and we would have seen bond yields spike.

But rates collapsed across the curve in response to the failure of SVB, the 16^th biggest bank in the US.

The sudden failure does not appear to be a systemic issue.

The failure was tied to the specific and concentrated nature of SVB’s depositors in the venture capital and cryptocurrency sectors. Deposits attributable to digital currency customers account for 82% of the deposit base.

It appears cash drain from the cryptocurrency fallout and cash burn on venture capital starts-ups led to cash withdrawals.

This forced SVB to sell $11.4 billion of its “available for sale” securities, including Treasuries, mortgage-backed securities and municipal bonds.

After the recent sell-off in fixed income markets, this crystalised a $1.8 billion loss.

Bank stocks were sold off on Thursday and Friday with investors concerned about the quality of bank balance sheets and outlook for net interest margins.

It’s difficult to know if this will be an ongoing issue, since most bank investment portfolios are held to maturity and not forced to mark to market.

There appears to be no issue with deposits in the US banking system.

This episode demonstrates that banks need to offer competitive rates to retail and business depositors, since they are now competing with Treasury bills that offer over 5% and money market funds that offer 4.5% to 5%.

This will squeeze net interest margins or possibly impact the amount of credit in the system. 

We have seen signs of credit tightening in response to the cycle.

But we don’t know if financial conditions are tight enough to dampen inflation enough to get back towards “normal”. 

Rate-tightening cycles normally work their way through the economy via housing, manufacturing orders, corporate profits and then employment – in that order.

The housing market reflects higher rates, as do new orders, which look bleak.

At this point sales have started to retreat but operating margins in the US remain elevated and profits resilient.

Employment remains strong, though history shows that when employment starts to deteriorate, it does so quickly.

Labour markets tend to be tight until they are not – then central banks realise they have over-tightened.

Australia

As expected, the RBA hiked rates 25bps to 3.6% last week.

The tone was less hawkish and markets are pricing a terminal rate of 4.14% in November 2023.

We are yet to see a meaningful slowdown in consumer data, though sentiment remains soft.

This is puzzling given some 17% of households borrowed at trough rates and 35% face higher rents.

Hiking rates is the only policy tool available to the RBA, though this only affects about half of households.

The other half remain cashed-up, while negative “real rates” on savings encourage continued consumption.

It’s no surprise that luxury goods and international travel spending remain strong.

 

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