Economics and Strategy
Less Risk for the Global Financial System, More Risk for the Main Street Economy
Jefferies’ Economics Team believes fears of contagion spreading within the financial sector will soon fade because banks are facing a liquidity crisis, not a solvency or credit crisis. But once liquidity fears pass, they believe Main Street could be hit by a credit crisis where small businesses soon find their access to credit restrained. For a long time now, Jefferies Economics has forecast a full-blown layoff cycle to begin at the start of the third quarter this year. The recent banking sector developments reinforces the team’s view that layoffs are coming soon.
Chief Market Strategist David Zervos pointed out that even if market participants had anticipated significant bank failures, most probably wouldn’t have correctly guessed the market responses. S&P 500 futures and the High Yield Corporate Bond ETF (HYG) are essentially unchanged, while 2-year Treasury yields have dropped precipitously. Looking through the lens of the rate volatility market this appears to be a global financial style crisis, while risk-assets suggest something like banal summer doldrums. The question is, should we be listening to the rate volatility market? David is sticking with his gut instinct from the immediate aftermath of the Silicon Valley Bank and Signature collapses and new Fed 13(3) funding structures: It might be bumpy in the near term, but savvy institutions will come through this stronger and capitalism will still work.
Global Head of Equity Strategy Christopher Wood says there is growing conviction that the Fed tightening cycle is coming to an end because of the assumption that credit conditions will tighten due to the banking-related stresses. He believes it is almost inevitable that the federal government will have to ultimately guarantee all retail depositors in the U.S. banking system to prevent continued deposit flight from regional banks. He anticipates that the U.S. stock market’s initial response to any coming Fed U-turn, and renewed easing cycle, should be positive, just as it will be negative for Treasuries. Nonetheless, Christopher still expects that 2023 will be the year when earnings downgrades hit the stock market if the US recession forecast proves to be accurate.
Global Equity Strategist Sean Darby noted that the recent reverberations in financial markets need to be set against Chinese GDP returning to trend while the European economies led by the Peripherals (Spain) are surprising on the upside. Further, Asian and Emerging Market equities have largely shrugged off the tightening in U.S. financial conditions, suggesting that they are better placed than in the past to deal with external shocks. One of his key tenets for 2023 is that the greater the divergence in central bank policies, the greater the dispersion in equity returns is likely to be. Sean continues to favor Japan, Northern Asia and the European bourses.