Good Tuesday AM,

Maybe less concern over the banking sector today as Treasury Secretary Yellen continues to reaffirm markets and consumers that their deposits are safe.

Markets are calming a bit but it is likely the calm before tomorrow’s storm of news and reaction with the Fed meeting.

The 10-yr Treasury has backed up to 3.57% and the 2-yr, which I don’t often mention, is 4.14. The reason to mention today is that the spread between the two continues to narrow. While the yield on the 2-yr should be lower than the 10-yr, once it inverts, it is a sign that recession is on the way. When it then un-inverts, well, the recession is more imminent. We are not anywhere close to this yet, but we are watching this.

The importance of tomorrow’s Fed announcement cannot easily be overstated. While I expect a 25bps hike and commentary shoring up the banking sector and reevaluating future hikes, it is a big unknown. On the scenario above, rates likely improve. If the Fed does not walk back any future hikes for the moment, rates will pop to the high side. The news breaks at 11a.m. Pacific so if you are floating overnight, be ready at the trigger by 11.

A little insight as to why banks can fall off a cliff so quickly.

Money managers, who must mark investments at market prices, sold a lot of their low-coupon Mortgage Bonds at a loss. But banks largely held on. They classified much of the debt as “hold-to-maturity,” which—unlike “available-for-sale” securities—can be marked at above-market prices because they are meant to be held until repayment. The strategy backfired on SVB when a rash of withdrawals forced it to sell the securities at a loss, triggering a run on the bank. Now bank analysts and Mortgage Bond investors alike are probing the holdings of other midsize banks out of fear their depositors will also lose confidence.

It’s not just Silicon Valley Bank.

Rising interest rates have cut the market value of U.S. bank assets and made the entire financial system more fragile. “The U.S. banking system’s market value of assets is $2 trillion lower than suggested by their book value of assets. We show that these losses, combined with a large share of uninsured deposits at some U.S. banks can impair their stability. However unlikely this is, if only half of uninsured depositors decide to withdraw, almost 190 banks are at a potential risk of impairment to even insured depositors, with potentially $300 billion of insured deposits at risk. If uninsured deposit withdrawals cause even small fire sales, substantially more banks are at risk,” University of Southern California’s Erica Xuewei Jiang and co-authors write in a working paper

Good news today…

Sales of previously owned homes rose 14.5% in February compared with January, according to a seasonally adjusted count by the National Association of Realtors. That put sales at an annualized rate of 4.58 million units. It was the first monthly gain in 12 months and the largest increase since July 2020, just after the start of the Covid-19 pandemic. Sales were, however, 22.6% lower than they were in February of last year. These sales counts are based on closings, so the contracts were likely signed at the end of December and throughout January, when mortgage rates had fallen sharply. The average rate on the popular 30-year fixed loan hovered in the low 6% range throughout January after reaching a high of 7% last fall.

Some more on the Fed from the WSJ

Federal Reserve Chair Jerome Powell and his colleagues this week face one of their toughest calls in years: whether to raise interest rates again to fight stubbornly high inflation or take a timeout amid the most intense banking crisis since 2008. The decision over whether to raise interest rates by a quarter-percentage point is likely to hinge in part on how markets digest the forced marriage Sunday of two Swiss banking giants, UBS and Credit Suisse, and other steps to calm fears of contagion in the banking system. Fed officials’ two-day meeting concludes Wednesday, Nick Timiraos writes.

The Fed has tried over the past year to telegraph its rate moves to avoid surprises and minimize volatility. Until now, it hasn’t confronted an abrupt and fluid crisis on the eve of a policy meeting. Central-bank officials who think lending and other financial conditions are at greater risk of tightening abruptly because of the banking shock could favor forgoing an increase. Those who see the effects as more likely to be temporary, contained, or modest could argue for pressing ahead with the next increase, aimed at cooling the economy, amid still-high inflation. The question is when does the next leg of the economic cycle begin.

The Consumer is already paying for it.

The question is how much pain tolerance is out there before people stop buying. I think we are coming close.

American consumers were already grappling with elevated inflation and rising interest rates. Now they face another test from banking sector turmoil and tighter financial conditions. Unrest in the banking sector could make it more difficult for some consumers to obtain loans to buy homes, cars and other big-ticket items, which would slow broader consumer spending. Economists say much of the near-term impact could depend more on Americans’ psychology—whether they have confidence the economy will weather the banking storm that might or might not directly hit their pocketbooks. Any spillover from the banking sector’s problems could threaten consumer spending, which accounts for about 70% of U.S. output, Gabriel T. Rubin reports.

Please remain safe and stay healthy, Make today great!