April 24, 2023
Afternoon results from FRC will impact near-term regional bank sentiment. Relatively stable deposit flows and unchanged loan growth guidance are the most surprising takeaways from those who reported last week. Two weeks ago, we suggested that some regional banks will choose to shrink in order to grow. Reports this morning suggest that PACW is considering the sale of its lender finance arm to shrink its balance sheet and free up capital.
Two year Treasury yields backed up to our technical objective near 4.25% last week. We think that level caps the upper end of the range for the cycle with support now at 4.05%. We expect 2-year yields will eventually break to the 3.45%-3.60% range. Ten-year yields reached similar resistance in the 3.65% range to a new objective near 3.20%. A break below 3.20% will confirm a peak in 10-year yields and feed further rotation into growth equity sectors. Note that past debt ceiling debates resulted in lower intermediate (5-10-year) Treasury yields as a ‘flight to quality’ trade preceded the perceived funding deadline.
In the near-term, we expect 10-year TIPS inflation breakeven yields will also fall to support near 209bp. Nominal yields holding 320bp and breakeven yields holding 209bp, would keep 10-year real yields above the 108bp level we’re using to trigger a larger overweight in Tech equities. The 5/10 yield curve inversion made a bottom near -36bp in early March. The confirmed bottom has us looking for a positively sloped 5/10 curve in the months ahead. During past tightening cycles, a positively sloped 5/10 yield curve preceded a Fed pivot by several weeks.
Near-term SPX: The S&P 500 (SPX) is in technical short-term overbought territory and looks fundamentally overbought relative to current terminal rate expectations of 5.10%. A rising cost of capital, ongoing monetary tightening and contracting money supply will eventually lead to accelerated disinflation. Unfortunately, these factors also lead to much slower growth and a likely recession. Equity markets have been relatively resilient despite the deteriorating macro backdrop. This is probably because everyone is already bearish, equity positioning remains light and sidelined cash in nominal terms is at record levels. These factors have also contributed to unusually subdued equity market volatility in the face of rising bond market volatility. But in the past, that dynamic has resulted in pent-up selling pressure and capitulation once technical support breaks. And late last week, trading action in the SPX triggered bearish momentum divergence signals.