Liquidity Drain

Liquidity Drain

We have another Fed policy meeting on Wednesday and then the April jobs report on Friday so next week is poised for some fireworks. The Fed will raise 25bps and then probably tease another 25bps for June as the economic data shows consumer spending, inflation and wages are high enough to continue their hawkish policies.

The risk to the banking system is that another 50bps by summertime has the potential to further drain deposits and weaken bank balance sheets. The earnings reports from the banks have shown some deposits moving among institutions but no clear winner which means that cash is going into money market funds and Treasury bills that now yield 5%. Banks do not have enough interest income from their loan portfolios to pay depositors a competitive rate if T-bills yield over 5% so this headwind will keep pressure on the banking sector.

And don’t forget about the Fed’s balance sheet that I have in the chart below. As you can see on the right side of the chart, the Fed ADDED to their portfolio in the wake of several regional banks going out of business. And this liquidity injection is temporary according to Powell so the remainder of the $400B added should come off the books in the coming weeks. I expect this will be something addressed at the Powell presser Wednesday afternoon.

Assets on the Fed Balance Sheet

The Stock Market

First Republic Bank

First Republic Bank was down 64% on Friday in a warning that stockholders will be wiped out as the Wall Street Journal is reporting suitors are lining up to buy the bank. Perhaps, they will keep the bank out of restructuring or maybe they will buy the stock for pennies but this bank was fine until the Fed pulled the pin on fighting inflation. Another example that stocks can go to zero and in this case rising interest rates was the main culprit.

The recent performance by the S&P 500 is being held up by a handful of stocks as roughly half of this year’s performance is owed to Microsoft, Amazon, Google, Meta, Nividia and Salesforce. This means most of the stock market is stagnant and leadership is narrow so if these leaders fail then down we go.

S&P 500 ETF

On close examination of the chart above, the Friday close is hovering below the $418 level which has been a level of strong resistance for over a year. If there is a breakout of this level then we could get a strong rally going over the summer months. On the downside, we need a break of $380 to get the bear market going again so we remain in a range of $380/$418 until further notice. Perhaps this coming week will give the market a catalyst to break this range.

Economic Data

Contributions to GDP
  • The U.S. economy grew at a 1.1% annual rate last quarter, a significant slowdown from 2.6% in the fourth quarter, the Commerce Department said. Consumers propped up growth with a surge of buying early in the year, while businesses pulled back sharply, drawing down inventories, cutting equipment purchases and reducing housing investment. (WSJ)
  • The Q1 Employment Cost Index saw private sector wages and salaries up by 5.1% compared to last year showing the Fed can justify further rate increases.
  • The S&P CoreLogic home price index in February rose 2.1% y/o/y which is the slowest pace since 2012. 
  • Pending home sales in March fell 5.2%from February as limited inventory curtails activity.
  • Taiwan’s economy contracted by 3% in Q1 and warns of a slowdown in semiconductors and technology.
  • A separate report from the Conference Board showed consumer confidence fell in March. Americans’ assessment of current business and labor market conditions improved, the business group said. But an index tracking expectations for the coming months dropped, dragging the overall measure down and signaling a looming recession.
Paul J. McCarthy III

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Paul J McCarthy III CFA

President, Kisco Capital

Paul McCarthy

Mr. McCarthy is the President and founder of Kisco Capital.