US jobs report overview, and the banking sector comes under stress

The US Non-Farm Payrolls report for February came in above expectations, with NFP growth at 311k, but the markets love it. Risk appetite has returned after Thursday’s sharp sell-off, stocks are higher, Treasury yields are lower, and the odds have fallen that the Federal Reserve will hike interest rates by 50 basis points when they meet later this week. So, what has changed, and why are markets seemingly ignoring the better-than-expected payrolls figure?

To answer the last part of that question first, we need to dig deeper into February’s labour market report. Firstly, the market had expected 205k jobs growth, the actual figure was 311k, so that was running hot. Secondly, the January figure was revised lower, but only marginally, from 517k to 504k. Thus, job growth in the US is still strong, although it has slowed considerably since January. However, the market is latching on to the unemployment rate, which rose from 3.4% to 3.6%, the highest level since November. Pay growth also slipped in February, down a notch from 0.3% to 0.2% on a monthly basis, the annual basis saw growth of 4.6%, which was higher than the 4.4% from January.

As you can see, the reasons the market is upbeat in this report are thin on the ground. The unemployment rate has only edged up slightly, and the participation rate, although a notch higher, is still roughly at the level it has been for the last 3 years. However, investors see signs of optimism, stocks are higher across the board, 2-year Treasury yields have fallen by 21 basis points, at the time of writing, and are back below 5%, however, it is worth noting that sentiment is wobbly as we move towards the end of the European trading week. After the rollercoaster ride of the last 24 hours, it is no wonder that traders are squaring up and setting off home early to take stock of some big moves in the market.

This payrolls report cannot be seen in isolation, after the news about Silicon Valley Bank broke on Thursday. This relatively small lender to tech start-ups, announced that it had lost $2bn on a sale of a bond portfolio following a larger than expected decline in deposits. It also announced a fresh capital raising and is selling $2.25bn of new shares. After falling 60% on Thursday, SVB’s share price fell a further 40% on Friday before trading was halted. The bank announced that it was seeking a buyer after it had not been able to raise capital.

This has knocked sentiment towards risk assets as we move into the weekend, but we do not think that SVB’s fate will lead to greater contagion across the US or global banking sector. Instead, it has opened the market’s eyes to the risks of an aggressive Fed hiking cycle on the global banking sector. The banking sector in the US is falling sharply again, the KBW banking index is down more than 6%. However, this index is made up of smaller banks, who are perceived to be more at risk from the SVB affair. Importantly, for global risk appetite, JP Morgan’s share price is up 1.5% today, suggesting that the market overreacted to the SVB news yesterday, which sent blue chip banks’ share prices tanking.

The next stage of this “contained crisis” as we like to call it, is to see if a larger competitor buys SVB, or if the Fed tries to save it from bankruptcy. We think the former is more likely, and the Fed is likely to keep well away from a bank that could only exist in the largesse days of VC funds. While we don’t doubt that the economic environment is challenging, this is not likely to cause a financial crisis in our view.

The silver lining is that now that a sub sector of the financial sector is showing signs of stress, it may force the Federal Reserve to tread carefully when it comes to future rate increases. According to the CME’s Fedwatch tool, the chances of a 50bp rate hike later this month is 49%, vs. 50% chance of a 25bp rate hike. This is down from a near 70% chance of a 50bp hike yesterday.

Below is some more detail on what is going on with SVB bank, and what it means for the broader banking sector.

So why did an obscure Californian bank cause this huge sell off, and how dangerous is it for the global banking sector?

-       It’s opened peoples’ eyes to the risks of a big rate shock, and higher for longer from the Fed, for the banking sector.

-       Banks tend to hold large bond portfolios to hedge their liabilities, these will have dropped in value due to the surge in government bond yields in recent weeks and months – the 2-year yield rose above 5% this week - its highest level since 2007. As government yields rise, their price falls.

-       The value of bonds (assets) that banks hold can fluctuate depending on the economic conditions, this is normal.

-       It only becomes a problem if banks are forced to sell these portfolios of bonds; that’s when they crystalise a loss. If this happens it can threaten their capital levels.

-       Some Banks are having to sell these portfolios if their deposit levels drop, which happened at Silicon Valley Bank, likely because of a drop in sentiment in the tech sector and the fact that government bond yields are rising, making Treasuries a more attractive investment than cash.

-       Post the financial crisis there are strict regulations on bank

-        capital ratios, to protect them from periods of financial crisis.

-       Hence why Silicon Valley Bank said that it had to raise capital on Thursday.

We don’t think that this will lead to a full-blown banking crisis, largely because banks are well capitalised on aggregate, although some smaller tech-focussed banks could be vulnerable.

However, it highlights the risks to the wider banking sector: 

1, deposits are being pulled due to more attractive yields elsewhere.

2, banks hold various levels of bonds in their portfolios to hedge their liabilities – these are falling in value, as bond yields rise. The US banking regulator, the Federal Deposit Insurance Corporation, said that banks are sitting on $620bn of combined unrealised losses in their securities portfolios.

3, However, banks have $2.2 trillion of equity at the end of 2022, so there is no need to panic – overall, the banking sector is well capitalised.