As Bank Risks Rise, Investors Back The US Economy

As recent financial turmoil and contagion fears have become prevalent, it appears that most of the people who participated in the MLIV Pulse survey are still optimistic about the performance of the US economy despite what the markets are doing.

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Stocks and bond yields plummeted after three US banks collapsed and others were rescued, including Europe's Credit Suisse Group AG and First Republic Bank. As Fed rate cuts are expected in the coming months, and recession warnings are expected to rise, bets on monetary tightening have been dialed back.

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While those trades give us an idea of what is to come, they seem hard to match the one we are supposed to see in the MLIV survey, which was conducted between March 13-17, with 519 retail and professional investors participating. A majority of respondents believe that a hard landing will be avoided, with about two-thirds saying that the economy will either have a soft landing, accelerate, or cruise, or will avoid it altogether. 

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There is investor support for the US economy

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Among the following questions, which one best reflects the shape of the underlying employment market in the years to come?

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After the collapse of Silicon Valley Bank, a survey was conducted before Credit Suisse stepped in at the weekend to save the bank from its worst bonds. This triggered concerns that a credit crunch could develop due to the loss of holders of the bank's riskiest bonds.

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Although historical evidence suggests that the Fed can rapidly pivot to monetary easing in order to deal with recession risks if they do materialize in the future, most economists lean towards a scenario in which the Fed ekes out some more rate hikes. 

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Market momentum and concerns that banking distress could snowball have pushed trades in an opposite direction to what investors believe will be likely economic outcomes. 

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Despite the avoidance of signaling what the next move would be for the European Central Bank, the ECB pushed ahead with its plan to raise interest rates by half a point as planned on Thursday, suggesting the fight against inflation has not been put on hold for central banks.

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This week we are spending some time with the Fed. More than 60% of retail and professional investors both agreed that it doesn't seem like the central bank has lost credibility, according to a survey conducted by MLIV.

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It will be up to investors on March 22 whether to take a quarter-point hike as part of a campaign to combat inflation or to take a pause due to concerns over financial stability. 

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It is important to ask oneself how much of the Fed's desired tightening will now result from banks turning cautious as the Fed's target of tightening the economy is being achieved. Credit spreads play an important role in influencing the real economy when markets are experiencing distress. Thus far, they have not widened to a level that indicates a significant slowdown.

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According to Goldman Sachs Group Inc. economists, tightening lending conditions are likely to impact the US economy by as much as 0.5%. This represents a significant impact but is not comparable to the level of alarm on the markets at this time. As is consistent with MLIV survey respondents' predictions, Goldman continues to predict a soft landing.

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A significant psychological impact has been felt by the banking turmoil, as well as a shift in the outlook for the Federal Reserve.

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As a Stanford University finance professor, Darrell Duffie told us, “the Fed will continue to tighten its policy in the long run so that inflation can be brought down. Among the most likely outcomes of the Fed meeting will be a temporary pause in rates, perhaps just until the next meeting following this one, and then the Fed will resume the rate hike as dictated by inflation data.”

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Inflation has been a constant concern for policymakers for the past year, but there has been little progress to show for it. A big real-economy shock from this month's financial events, on the other hand, is a risk, not a given, or even a likely outcome. 

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Even if the US central bank decides to give markets a chance to stabilize this week, there is a possibility that it will take a hawkish pause. This would increase the risk of further interest rate increases even if the Fed pauses this week.

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Inflationary threats have been identified by Federal officials as the hiring boom and rising wages. The majority of MLIV respondents say the jobs market either has slowed down already or will shortly. As a result of the shortage of workers, one-third of respondents believe that this year will not be a very cold one, and the increase in interest rates will instead result in a smaller profit margin.

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There seems to be not much chance of a soft landing, with Bloomberg Economics estimating that it is close to a foregone conclusion that there will be a recession in the third quarter of this year. Fed hikes have historically broken things down, and this cycle is likely to continue that trend.

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In Matthew McLennan's view, plunging yields in the last week are one of the biggest signals being sent by plunging yields in the next few months, as he co-heads First Eagle Investment Management's global value team.

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As he explained, the bond market is telling you that the Fed has taken the last block out of the Jenga stack. The financial stress will probably slow the growth of lending, which will have a negative effect on nominal growth, which in turn could lead to a recession. You can imagine the impact it could have on the economy.