Throughout Q1, I talked about how March looked like the month where we could see volatility start to pick up and April as the point where we could see risk assets start to correct. This has mostly played out thus far. Conditions favored volatility picking up towards the end of March, but it ended up happening earlier when Silicon Valley Bank and Signature Bank failed.
April looked as if the first half could see more favorable conditions based on the direction of the risk signals and prevailing market sentiment, but vulnerable to a correction in the second half. In terms of narrative, the banking “crisis” turned out to be much less threatening than originally feared, the expected path of Fed rate interest increases in 2023 dropped substantially and inflation continued to slow. All of these contributed to a general bullish sentiment that was reflected in the asset classes I watch most closely. Over the past couple weeks, large-caps rose. Small-caps began outperforming again. Treasuries lagged. Even lumber prices popped, something we haven’t seen in a while, and the VIX is down to its lowest level in more than a year.
Investors think life is good, but I believe we could be reaching the point where the broader macro picture starts to matter. Whether you want to look at the housing market, the labor market, the Treasury yield curve or the actions of the Fed, there’s a pretty convincing story being built here that something could soon break.
The trigger could be the debt ceiling, which came back to the forefront this week when Republicans in the House unveiled their proposal to lift the cap. Not surprisingly, both sides of the aisle are dug in hard and, despite the fact that the debt ceiling is more of a political prop than anything, it’s a black cloud of uncertainty that the markets don’t need right now. Just like in 2011, an agreement could come down to the wire, resulting in a lot of volatility in both stocks and bonds.
The newer development is that the deadline to reach a deal could be coming a lot sooner than originally thought.
In the past, Janet Yellen said that extraordinary measures were expected to run out in August or September. This really accelerates the timeline of needing to get something done and is probably a contributing factor to why both Republicans and Democrats have shown more urgency in their desire to get back to the negotiating table.
For their part, stocks haven’t really reacted, but perhaps that’s not surprising because they didn’t in 2011 either. At least at first.
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