Equity and bond markets have calmed since last month’s regional bank failures sparked contagion fears, but political brinkmanship over the U.S. debt ceiling risks reigniting volatility, warns CreditSights.
“There has been no discernible progress made on a deal, which is likely to result in debt ceiling negotiations coming down to the wire once again,” CreditSights analysts led by global head of strategy Winnie Cisar said in a note Monday.
For now, “across asset classes, volatility has subsided since peaking in mid-March after the collapse of SVB on March 10th and a hotter-than-expected February CPI print on March 14th left the Fed balancing financial system risk with persistent inflationary pressures,” the analysts said. They’re referring to the failure of California’s Silicon Valley Bank as well as data from consumer-price index, or CPI, which is a gauge of U.S. inflation.
“Markets have generally calmed from a relatively brief (at least so far) bout of intense volatility” after actions by the Federal Reserve, U.S. Treasury Department, and Federal Deposit Insurance Corp. “to support regional banks and insure all deposits” of failed SVB and Signature Bank, said the analysts. New York’s Signature Bank collapsed two days after SVB.
In the chart below, CreditSights tracked volatility in equities, interest rates and the currency market, using the Cboe Volatility Index, known as the VIX, as well as the bond market’s ICE BofAML MOVE index and the J.P. Morgan Global FX Volatility index, according to the report.
“All three volatility measures are now below” levels seen at the end of 2022, with equity volatility dropping 32% from its March peak, while “interest rate vol” has tumbled almost 40% from its high last month, according to the CreditSights note. As for currencies, volatility in the foreign-exchange, or FX, market has seen “the smallest fluctuation across the three broad asset class categories” but still is down 18% from its recent peak.
“The U.S. economy, and global economy for that matter, have proven resilient to start 2023 even in the face of dramatic monetary policy tightening over the past year,” the analysts said. The Federal Reserve has been tightening monetary policy by aggressively raising interest rates over the year to battle high inflation.
Debt ceiling
Politics in Washington may escalate investor anxiety this summer.
U.S. House Speaker and California Republican Kevin McCarthy on Monday delivered a speech at the New York Stock Exchange, reiterating his call for President Joe Biden to negotiate over raising the U.S. debt limit. McCarthy and Republicans have demanded spending cuts in exchange for raising the ceiling for federal borrowing.
See: McCarthy calls for Biden to negotiate on raising debt limit, rather than ‘bumble into’ the first U.S. default
White House deputy press secretary Andrew Bates on Monday reiterated the Biden administration’s call for House Republicans to agree to lift the debt limit without conditions. “Speaker McCarthy is holding the full faith and credit of the United States hostage, threatening our economy and hardworking Americans’ retirement,” the White House spokesman said.
McCarthy said the House will vote in the coming weeks on a proposal that would suspend the debt limit for a year, return federal spending to levels seen in fiscal-year 2022 and limit outlay growth over the next decade to 1%. “Our proposal will also restore work requirements that ensure able-bodied adults without dependents earn a paycheck and learn new skills,” he said.
U.S. stocks were trading modestly higher Monday afternoon, with the Dow Jones Industrial Average
DJIA,
-0.11%
and S&P 500
SPX,
-0.46%
and Nasdaq Composite
COMP,
-0.75%
each up around 0.2%, according to FactSet data, at last check. The U.S. stock market has risen so for this year, with the S&P 500 climbing 8% based on Monday afternoon trading levels.
The VIX, known as the stock market’s fear gauge, was trading at about 17 on Monday afternoon, below its long-run average of around 20. The VIX
VIX,
+0.48%
had jumped above 30 in mid-March amid regional-banking fears.
CreditSights analysts are worried about the lack of negotiation so far in this year’s debt-ceiling debate.
It could wind up being similar to the “showdown” in 2011 that led to a downgrade of the federal government’s credit rating, “financial market turmoil and lasting negative effects on the economy,” they said.
“We ultimately expect Congress will avoid a U.S. default, but with early estimates of the “x-date” (when Treasury may run out of cash) beginning in June, the potential timing for the debt ceiling to be a more pronounced volatility-inducer is nearing,” the analysts wrote.
Meanwhile, shares of the iShares Core U.S. Aggregate Bond ETF
AGG,
-0.18%,
which invests in U.S. investment-grade bonds including Treasurys, were down around 0.5% Monday afternoon, according to FactSet data, at last check. So far this year, the fund has seen a total return of 3.2% through Friday.
As for below-investment-grade debt, the SPDR Bloomberg High Yield Bond ETF
JNK,
-0.46%
was down modestly Monday afternoon, but so far in 2023 has posted a 4.3% total return through Friday, FactSet data show.
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