What financial crisis? US economy has investor backing, survey shows

MARKETS have been trading as if the end of the world is at hand, but what most participants see – behind the recent financial turmoil and contagion fears – is a still-strong US economy, Bloomberg’s latest MLIV Pulse survey shows.

The collapse of three US banks and the scramble to rescue others, including Europe’s Credit Suisse Group and First Republic Bank, sent stocks and bond yields plunging. Bets on Federal Reserve (Fed) monetary tightening were dialled back, swap contracts are reflecting expectations for rate cuts within months, and recession warnings are ramping up.

Yet the world foreseen in those trades is hard to square with the one outlined by 519 investors – retail and professional – who took part in Bloomberg’s weekly survey between Mar 13 and Mar 17. Most respondents believe that a hard landing will be averted, with about two-thirds predicting that the economy is either heading towards a soft landing, accelerating or cruising.

Most lean towards a scenario in which the Fed ekes out some more rate hikes, to bring inflation closer to its target. 

The survey findings suggest a mismatch between what investors see as the likely economic outcomes and the direction that trades have taken – driven by market momentum and concerns that banking troubles could snowball. 

‘Irrational fear’

Greg Peters, co-chief investment officer of fixed income at asset manager PGIM, said: “The thing about contagion risk is, it’s really about the spread of irrational fear.” 

The Swiss National Bank’s pledge of support for Credit Suisse helped calm the chaos. And the European Central Bank (ECB), which went ahead as planned with a half-point increase in interest rates last Thursday (Mar 16), suggested that inflation-fighting has not moved to the back burner for central banks – even though the ECB avoided signalling what comes next.

This week, it is the Fed’s turn. The US central bank still enjoys investor confidence, based on the MLIV survey. More than 60 per cent of the retail and professional investors who responded said it has not lost credibility.

Investors predict that the upcoming Mar 22 decision will be between a pause – on financial stability concerns – and a quarter-point hike to continue the inflation-busting campaign. 

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One key question is how much of the Fed’s desired financial tightening will now happen as a result of banks turning cautious. Credit spreads are an important channel through which market distress affects the real economy. So far, they have not widened to a degree that implies a significant slowdown.

Goldman Sachs Group economists estimate the likely impact from tighter lending conditions at up to 0.5 per cent of US gross domestic product – a significant hit, but not commensurate with the degree of alarm in markets.

The Goldman team continues to predict a soft landing, consistent with MLIV survey respondents.

‘Long-run path’

The banking turmoil has clearly had a psychological impact, shifting the Fed outlook as well. Nearly half of the MLIV respondents said that a 50-point hike, the base case not long ago, would add to financial-system risks after the collapse of Silicon Valley Bank, which was the biggest US bank failure since the 2008 aftermath.

“The Fed is still on a long-run path of tightening policy to bring inflation down,” said Darrell Duffie, a Stanford University finance professor. “The most likely path for the Fed is... a temporary pause in rates, maybe just until the next meeting after this coming one, and then the Fed would resume as dictated by data on inflation concerns.”

For the Fed, a big real-economy shock stemming from this month’s financial events is a risk, not a foregone outcome or even a likely one – while persistently high inflation is a fact, one that policymakers have battled against for a year with little progress to show so far. 

So even if the US central bank chooses to pause this week, it could be a hawkish pause, one that allows markets to stabilise but increases the risk of more hikes to come.

Last Jenga block?

Fed officials have flagged the hiring boom and rising wages as main inflationary threats. The majority of MLIV respondents said the jobs market is either softening already, or will soon. Roughly one-third said that the shortage of workers means there may not be much cooling this year, and that higher rates will instead compress profit margins.

The Bloomberg Economics view is that a soft landing remains an outside bet, with a 75 per cent chance of a recession in the third quarter of this year. Fed hikes have in the past mostly ended up breaking things, and this cycle is likely no exception.

That was broadly the signal sent by plunging yields in the past week, noted Matthew McLennan, co-head of the global value team at First Eagle Investment Management.

“The bond market is telling you that the last block has been taken out of the Jenga stack by the Fed,” he said. After all the banking stress, “lending growth will probably slow – which raises the probability that nominal growth slows”.

He added: “You can see how this could translate (into) a recession.”

MLIV Pulse is a weekly survey of readers of the Bloomberg Professional Service and website, conducted by Bloomberg’s Markets Live team, which also runs a 24/7 MLIV blog on the terminal. BLOOMBERG