March 23, 2023
A week-long back up in 5-year Treasury yields stalls out at moving average price support near 3.80%. The decline in 5-year yields looks like it will resume with a near-term target of 3.30%. The outlook for lower 5-year yields opens the door for the 5/10 curve inversion to narrow further, which could have bullish implications for equity markets. The 5/10 curve inversion is now -2bp and sustained closing levels above -7bp starts the clock for a bottom in equity markets 1-5 months forward. A positively sloped 5/10 yield curve would signal an imminent Fed pivot.
The SPX remains relatively resilient as investors look through near-term economic pain on expectations for an eventual Fed pivot. Our bullish long-term outlook is predicated on an eventual pivot leading to a cyclical recovery, but stay tactically bearish based on the Fed’s higher pain threshold.
An expected collapse in bank lending is the catalyst for near-term economic pain. Cash on hand is the only stable way for banks to meet deposit outflows. At the end of last year, banks had an average of 3% in cash on hand. Given recent events, no bank wants to end Q1’23 with less cash than they had at the end of last year. A bank’s only organic way to increase cash is to retain proceeds from maturing loans. Commercial real estate loans have attracted the most attention recently. Regional banks account for ~70% of commercial real estate lending and there’s an estimated $330B maturing this year. Loans from the Fed’s emergency bank facility are charged at the Fed funds rate, which is now 5%. Borrowing from the Fed to make ~5 year commercial real estate loans with credit risk seems like a bad business model. Increasing FDIC insurance limits will slow the pace of deposit flows, but the only way to fix the banking business model is through a positively sloped yield curve. A positively sloped yield curve has bullish implications for equities and Tech in particular, but the economic pain to induce a policy pivot may be greater than most expect.