Weekly Research Briefing: Frozen

The FOMC raised the target range for the federal funds rate by 0.25pp to 4.75-5%. The post-meeting statement noted that, while the “banking system is sound and resilient,” the recent banking stress is likely to “weigh on economic activity, hiring, and inflation." The FOMC removed the reference to “ongoing” hikes in the post-meeting statement and noted instead that “additional policy firming may be appropriate.” The Committee reiterated that it “remains highly attentive to inflation risks.” The median dot in the Summary of Economic Projections shows a funds rate of 5.125% at end-2023, unchanged from the December projections. The median projection in the SEP showed lower GDP growth and somewhat higher core inflation in 2023 and 2024.

For the first time in a year the Federal Reserve has left its next policy step in doubt as officials weigh the risks of continued high inflation against a possibly looming U.S. credit crunch that could slow the economy in sharp and potentially unexpected ways.

Walking a narrow line that could leave financial markets both unsettled and guessing about what's next, Fed Chair Jerome Powell said in a news conference that U.S. central bank officials will themselves be in the dark until more is known about how banks might change their lending behavior in response to the failure of two regional lenders caught out by unexpected deposit runs…

"It's really ... a question of not knowing at this point," Powell told reporters after the meeting. "How significant will this credit tightening be, and how sustainable? ... This is 12 days ago," that a pair of bank failures reshaped the financial landscape facing the central bank, with potential implications for the real economy and the path of inflation.

The Federal Reserve approved another quarter-percentage-point interest-rate increase but signaled that banking-system turmoil might end its rate-rise campaign sooner than seemed likely two weeks ago. The decision Wednesday marked the Fed's ninth consecutive rate increase aimed at battling inflation over the past year. It will bring its benchmark federal-funds rate to a range between 4.75% and 5%, the highest level since September 2007.

Fed Chair Jerome Powell said officials had considered skipping a rate hike after banking stress intensified last week. And he hinted that Wednesday's increase could be their last one for now depending on the extent of any lending pullback that follows a bank run earlier this month. Regulators shuttered Silicon Valley Bank and a second institution, Signature Bank, two weeks ago, and bailed out uninsured depositors to stave off a panic.

Estimates of just how much any credit contraction could reduce hiring, economic activity and inflation were "rule-of-thumb guesswork, almost, at this point. But we think it's potentially quite real, and that argues for being alert as we go forward," Mr. Powell said at a news conference after the Fed's policy meeting. Later, he said, "it could easily have a significant macroeconomic effect."

Chairman Powell made it very clear that the FOMC’s framework has shifted. Their baseline assumption is now that the banking system stress has acted as at least the equivalent of a rate hike, and probably more than that. Their new disposition is to be cautious on further hikes unless and until they see evidence that economic drags will be minimal.

U.S. Dollar weakness is likely to resume for several reasons. There are several forces at work. First, the collateral backstop put in place after the SVB bankruptcy is a form of easing, we believe, even though Powell said it is not intended to alter the stance of monetary policy. Second, the Fed’s shift to “some additional tightening” from “ongoing rate increases”, is a dovish statement for the ultimate path of U.S. short-term interest rates. A weaker USD should be a tailwind for global risk assets, as well as U.S. exports, which are currently running 21% below trend.

Federal Reserve Bank of Minneapolis President Neel Kashkari said recent bank turmoil has increased the risk of a US recession but that it was too soon to judge what it means for the economy and monetary policy.

Asked on Sunday during an interview on CBS’s “Face the Nation” if the strains could tip the country into a recession, he said, “It definitely brings us closer.”

“What’s unclear for us is how much of these banking stresses are leading to a widespread credit crunch. Would that slow down the economy? This is something that we’re monitoring very, very closely,” said Kashkari, a voter on monetary policy this year. “It’s too soon to make any forecast about the next interest rate meeting.”

The next meeting of the policy-setting Federal Open Market Committee is May 2-3.

The capital markets have been on ice since the collapse of Silicon Valley Bank two weeks ago.

No companies with investment-grade credit ratings sold new bonds over the six business days from March 10 through March 17, the first week in March without a new high-grade bond sale since 2013, according to PitchBook LCD. The market for new junk-bond sales has largely stalled this month, and no companies have gone public on the New York Stock Exchange in more than two weeks.

March is typically busy for new corporate debt financings: Companies look to secure financing before the blackout period between the end of the first quarter and the kickoff of earnings season, when they typically refrain from bond sales. Lately, a lack of investor confidence and wild swings in the Treasurys market have kept companies on the sidelines.

Those with the highest ratings have sold $59.9 billion in new bonds this month, compared with March’s five-year average of $179 billion. The riskier corporations that borrow by issuing higher-yielding junk bonds and leveraged loans are finding it even harder to sell new debt. Companies have raised some $5 billion of junk bonds this month versus the five-year average of $24 billion.

"It's just obvious they have zero appetite for talking about venture debt," Mr. Sanders said, referring to a loan in which a venture-backed company's assessed value serves as collateral. SVB provided debt capital on reasonable terms to private technology companies, and had $74 billion in loans to startups, investment firms and other clients as of December.

Many lenders say they are seeing more demand from borrowers since regulators took over SVB. But lenders often aren't ready to serve early-stage companies the way SVB did, and when they do, their loans are likely to be smaller, more expensive and have more stringent terms.

Conditions in debt markets were already growing worse for startups before SVB's collapse, with rising interest rates and increasing risks in the tech market...

Big banks are out of touch with the unique needs of venture-backed startups, Mr. Rosenblatt said. "They have no service layer to support seed and early Series A companies that are doing under $5 million in revenue," he said. "They certainly don't know how to underwrite lines of credit for these companies." Nonbank lenders also aren't likely to offer startups deals as flexible as ones from SVB.

"SVB was dirt cheap," said Sajal Srivastava, co-chief executive and co-founder of TriplePoint Capital, a nonbank lender that competed with SVB for venture-debt clients. "We don't have deposits to subsidize those cheap loans." SVB could lend to earlier-stage borrowers at cheaper rates because it had a lower cost of capital in the form of bank deposits, and it generated higher revenue per borrower with banking products.

Homebuilder sentiment has improved for three consecutive months. While it’s not quite back to a neutral level of 50, fears of another backslide have abated. Instead of builders sitting on a glut of unsold homes that they had begun building during the pandemic, last week's housing data showed that the number of single-family homes under construction has fallen to the lowest level since October 2021.

And after bottoming in November, single-family housing starts have picked up a bit — not the surge we saw in mid-2020, but another sign that builders feel like they are in a position to continue building in the current market rather than pulling back even more.

One of the largest homebuilders in the US, Lennar Corp., noted in its earnings call last week that its February cancellation rate “was 14%, much below our normalized cancellation rate.” They also said that base prices have stabilized in all of the markets they operate in.

@conorsen: $KBH: “Our gross orders improved significantly on a sequential basis, with January's orders increasing 64% relative to December, and February increasing 58% versus January.”

@LizAnnSonders: February new home sales +1.1% vs. -3.1% est. & +1.8% prior month (rev down from +7.2%) … third consecutive monthly increase, which hasn’t happened since 2020; median new home price +2.5% year/year to $438,200

*(US) FEB EXISTING HOME SALES: 4.58M V 4.20ME; Y/Y median price turned negative for first time in 131 months Metrics:

• Median existing home price: $363K, -0.2% y/y
• Months supply: 2.6 v 2.9 prior
• Distressed sales: 2% v 1% prior
• First-time buyers were 27% percent of sales v 31% m/m NAR's Yun: Conscious of changing mortgage rates, home buyers are taking advantage of any rate declines. Moreover, we’re seeing stronger sales gains in areas where home prices are decreasing and the local economies are adding jobs. Inventory levels are still at historic lows. Consequently, multiple offers are returning on a good number of properties.

A record amount of commercial mortgages expiring in 2023 is set to test the financial health of small and regional banks already under pressure following the recent failures of Silicon Valley Bank and Signature Bank.

Smaller banks hold around $2.3 trillion in commercial real estate debt, including rental-apartment mortgages, according to an analysis from data firm Trepp Inc. That is almost 80% of commercial mortgages held by all banks.

With the banking industry in turmoil, regulators and analysts are growing increasingly concerned about commercial real estate debt, particularly loans backed by office buildings, according to industry participants. Many skyscrapers, business parks and other office properties have lost value during the pandemic era as their business tenants have adopted new remote and hybrid workplace strategies.

High interest rates also have wreaked havoc with commercial property valuations. Many owners with floating-rate mortgages have to pay much more monthly debt service, cutting into their cash flows. Owners with fixed-rate mortgages will feel the pain of higher rates when they have to refinance.

This year will be critical because about $270 billion in commercial mortgages held by banks are set to expire, according to Trepp—the highest figure on record. Most of these loans are held by banks with less than $250 billion in assets.

The commercial real estate market is naturally dependent on leverage, giving banks an instrumental role in facilitating transactions. Through the end of 2022, the amount outstanding of commercial mortgage loans in the US stood at $5.6 trillion. Over half of this stock sits directly on commercial bank balance sheets, with small banks capturing a much larger share than large banks (Exhibit 1). Including mid-sized banks (i.e. banks with less than $250 billion in assets), our economists estimate that the combined share of small and mid-sized banks is 80% of the overall stock of commercial mortgage loans. Excluding the securitized CMBS market, banks originated over 40% of commercial mortgage loans in the first half of 2022.

@LizAnnSonders: U.S. regional banks account for ~70% of all CRE loans; while S&P 500 Real Estate has lagged its parent index by 7% MTD, Markit CMBX BBB S14 Index (synthetic tradable index referencing basket of 25 CMBS), is -12% MTD

[SON] Raises Q1 $1.30-1.40 v $1.18e (prior $1.15-1.25); Cites lower costs, higher demand - Sonoco anticipates results to be better than previously expected due to improving productivity, lower than expected input costs, and higher demand than forecasted in certain products and end markets.

The Big Picture:

• 11 S&P 500 companies have reported results that get classified as 1Q 2023.
• Despite increased angst over banks, and a slowing economy, we are very surprised to report that these 11 companies have collectively seen their 2Q 2023 EPS estimates rise, on average, by +0.14% after releasing results this month.
• This is better than last quarter when these same 11 companies had their next quarter EPS estimates fall at a rate of -0.37%.
• It is still only 11 companies, or 2% of the S&P 500 index, so the sample size is not yet significant.
• However, it remains a remarkable start given the macro environment.

March 19, 2023: Timeshares
TV-MA | 35 MIN
John Oliver discusses timeshares, how people get into them, why it’s so difficult to get out, and one exciting new business venture.