US 10-Year Treasury Yield
1. Any more bank failure?
The Bank crisis stabilized after the UBS takeover of Credit Suisse and First Republic Bank injected deposits to restore confidence. We can’t rule out any bank failure in Q2, especially the collapse of Lehman Brother after the rescue of Bear Stearns.
Having said that, the material difference between now and the global financial crisis is the asset quality, that the subprime loan is basically at default while the long-term treasury and MBS many banks are holding now can recoup the floating loss if they can be held until maturity. The situation will improve with time.
The drop of treasury yield because of risk aversion is also a self-cure mechanism that reduces the floating loss, and lower depositors’ incentive to move money out from the banking system. Therefore, the level of Treasure yield is an important factor to determine whether a bank run might occur again, since a higher yield means a bigger deposit outflow to seek better yield return and a bigger loss of bank asset. The resurge of yield will worsen the sentiment and dampen confidence. Another good indictor is the size of emergency funding facilitates that Fed is providing to banks. If there is a sudden increase on the size, this could imply there might be another bank in trouble.
2. How lending be impacted after the bank crisis?
Although Fed set the policy rate, it is the Bank to lend money in a rate they desire to the business and individual. In order to improve and avoid further deterioration of asset quality, Bank might take a more conversative approach in lending. The outflow of deposit also reduced Bank’s ability and willingness to lend. Since FDIC is asking Banks to pay the bill for saving SVC and Signature Bank, together with US government is seeking a tighter regulation for banking sector and many bank need to increase deposit rate to keep deposit, higher capital/operating cost might make Bank more selective and ask for higher lending rate to compensate the cost, that is not good for the whole economy.
3. Inflation trend?
Even OPEC+ surprised the market by cutting production that boost price, Energy should still strongly pressure headline inflation downward in Q2, especially on a YOY basis. NYMEX WTI crude oil $Light Crude Oil - main 2305(CLmain)$ traded above $100 most of the time in Q2 2022 and reached $123. Compare to current energy price, there will be an obvious negative impact in headline inflation. The delayed effect of lower property price and rent should also drive the inflation lower. We have seen some signs of lower service inflation, and if banking crisis harm business confidence, we might see a less tight employment market and a less wages growth. Despite OPEC+ action might make thing a little bit complicated, we might still see some decent drop in inflation in Q2.
4. Fed to end hiking cycle after May’s meeting?
May could be the last hike in this cycle. As mentioned, the inflation is cooling down and bank crisis will hurt the economy. Fed will also avoid hiking rate too much that will drive the Treasury yield up that might refuel the bank crisis. February Core PCE is trending lower, so as long as inflation doesn’t accelerate, a full stop of hiking cycle after May’s meeting will be a reasonable bet.
5. Recession possibility?
Inverted yield curve and ISM survey pointed to recession. Q2 could be the turning point of economy growth and we might see some slowdown. Recession has become base case scenario to many investors and they will allocate their asset and conduct trading strategy accordingly. If inflation under control and GDP growth, probably in Q3, recorded a deeper-than-expected negative growth, Fed might start easing by the end of this year.
6. End of War?
Russia-Ukraine war could enter the decisive phase in Q2 when Ukraine could launch the counter attack in Spring. It is very hard to predict the outcome but assuming Russia lost the war, the geopolitical ecosystem might be rewritten as well as the regime. How ally of Russia react is also highly unpredictable.
CME Nasdaq 100 Emini Futures
With interest rate hike cycle coming to the end, there might be more rooms for Treasury yield to go lower. This will benefit growth stock so Nasdaq $E-mini Nasdaq 100 - main 2212(NQmain)$ might outperform Dow $E-mini Dow Jones - main 2212(YMmain)$ again, adding to the gap built in Q1. Recession fears is not friendly to most of the commodities (except gold), and any big change on War might mean a lot to many cyclical commodities such as oil, natural gas, nickel and more.
Good Luck and Good Trading in Q2.
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