Markets rally on lower rates, then reverse

Following the horrific terrorist attacks by Hamas in Israel last weekend and the beginning of war between the two, markets reacted as expected when they opened for business this week. Safe-haven assets like US Treasuries and Gold rallied; however, stocks, which normally would have sold off, also rallied. Then, after a slightly higher-than-expected inflation (CPI) print on Thursday and a poor US treasury auction that afternoon, rates reversed course, and so did stocks.

• Wars draw market participants to safe-haven assets, which have historically been US Treasuries and gold
• Markets have recently been very focused on the relentless rise in yields on US treasuries, and this demand reversed the trend to begin the week
• Normally, in times of war, investors flee risk assets like stocks; however, given so much focus on rising yields and their negative effect on risk assets, stocks rose to begin the week
• Following a firmer-than-expected inflation reading on Thursday and a poor US treasury auction, yields reversed course higher, and stocks lower
• We have noted that one of several reasons for higher yields was the very large amount of US treasuries that needed to be sold before year-end
• The US treasury sells bonds via regular auctions, which are widely monitored for demand dynamics
• The market didn't like the lackluster demand from foreign buyers of the recent 30-year bond auction, which caused yields to spike higher again, causing stocks to sell-off

Big banks report earnings

This Friday, we saw earnings from JP Morgan, Wells Fargo, and Citi, three of the country’s largest national banks, and PNC, one of the largest regional banks in the country. All three national banks beat earnings expectations, with JP Morgan being the outlier, growing earnings by 35% on the back of its First Republic acquisition earlier in the year. While Wells Fargo and Citi also beat expectations, they reported much more modest growth in revenue and earnings. PNC Financial missed revenue expectations and guided to a lower net interest income for the following quarter.

• Banks have come into focus, given several large failures earlier in the year
• They are also a window into how the consumer is faring in the late stages of a stimulus-driven economic cycle
• Thus far, the banks continue to report a healthy consumer, with manageable credit losses and continued growth in spending
• Another important issue for banks is net interest income, which is the difference between what they pay their clients on deposits and what they receive on loans they make
• JP Morgan, Citi, and Wells Fargo all reported significant growth in net interest income, while PNC reported a decline
• The national banks continue to see less pressure to raise interest rates on deposits as opposed to the regional banks
• Consumers view the large national banks as safer and hence do not demand as much interest
• The market will continue to focus on this dynamic as it pertains to the regional banks in the near future

The consumer expects higher inflation

The University of Michigan Consumer Sentiment Survey showed a decline of about 7% this week after several months of little change. This was primarily due to the assessment of personal finances, which declined 15%, largely due to increased inflation expectations. The survey showed consumers expected 1-year inflation to be 3.8%, rising from 3.2% last month and the highest reading since May.

• Consumer inflation expectations are an important measure that provides insight into potential consumer behavior
• If consumers expect inflation to keep rising, they will likely purchase goods and services today instead of waiting
• This creates demand and potentially causes the prices of goods and services to rise, creating a self-reinforcing loop
• The Federal Reserve pays attention to this survey given the psychological dynamic that can create this feedback loop