Banking crisis continues, economy doing better than everyone thinks

Chart of the week

The chart shows the development of the global money supply (yellow) and the performance of the U.S. stock index S&P 500 (black).
Why it matters
Central banks greatly increased the money supply during the COVID crisis to support the economy. But it turned out that almost 1/3 of the money did not flow into the economy, but into the stock market.

Therefore, it is nothing but logical that if the central banks reduce the money supply, the money could flow out of the stock market again. This is what happened last year.

Because of the banking crisis, the central banks have now massively increased the money supply again. The money has not yet flowed into the stock market in a big way, but this is probably an important reason why the stock markets are currently holding up so well.

Banking crisis continues,
Last week, the next US regional bank, First Republic Bank went bust. It was bought up by JP Morgan, or rescued.

The chart shows bank failures in the USA over the past 30 years. The chart illustrates how large the current banking crisis is in historical comparison.

3 of the 4 largest bank failures occurred in 2023.

The chart shows how high the defaults at the banks are compared to the gross national product of the USA. The level of the crises of 2008, 1992 or 1929 has not been reached for a long time. What is worrying, however, is that another bank fails every 2-3 weeks.

In the U.S.A., banks are not required to carry investments they hold to maturity at market value. They are allowed to include them in the balance sheet at nominal value. In Europe, it's different. The chart shows how high these unrealized losses are at the banks, lying dormant on their balance sheets. We are talking about 30% of the banks' total Tier 1 capital. 1/3 of the total reserve capital is currently tied up in unrealized losses. It would therefore not be surprising if there are more banks that would fail.

In the U.S.A., banks are not required to carry investments they hold to maturity at market value. They are allowed to include them in the balance sheet at nominal value. In Europe, it's different. The chart shows how high these unrealized losses are at the banks, lying dormant on their balance sheets. We are talking about 30% of the banks' total Tier 1 capital. 1/3 of the total reserve capital is currently tied up in unrealized losses. It would therefore not be surprising if there are more banks that would fail.

U.S. Federal Reserve Policy
Last Wednesday it was that time again. The US Federal Reserve announced the new interest rate decision. As expected, interest rates were increased by 0.25%. However, the media release is always important.

The chart shows the Federal Reserve's March and May media releases with changes highlighted in change mode. The first thing that stands out is how consistently the central bank provides information and only changes individual words. This shows consistency.

As of last month, two changes stood out:

- In March it was still said that the interest rate environment would lead to stricter conditions for borrowing. Now it says credit conditions have worsened. So the FED does not expect any further deterioration in the future.

- The last red sentence in the chart, which has been deleted, indicates that no further interest rate hikes are planned.

The stock market reacted positively to the new interest rate decision accordingly.

The chart shows how much the expectation of interest rate development has changed in the last month. Just a month ago, the first interest rate cut was expected at the beginning of 2024. Now, this is expected to take place as early as mid-2023.

We consider these expectations to be too optimistic. It assumes that the economy will cool down noticeably.

The chart shows what many market participants are thinking. The sharp increase in key interest rates in the USA (gray line) will put a massive brake on consumption, which will lead the economy into recession. Since inflation is also declining, the central bank will soon be able to lower interest rates again.
The reality currently looks different. The good stock market sentiment on the interest rate decision did not last long.

The number of new jobs created in the USA was published on Friday. For the 13th time in a row, these were stronger than expected. This has never happened in the past 20 years.

Everyone expects the economy to cool, but companies continue to hire more people.

The chart shows the creation of new jobs in the USA (excluding the volatile agricultural sector). The average of the past 10 years is shown in blue, and the trend in 2022 is shown in green. Compared with last year, the pace of new job creation has slowed only minimally and remains above the long-term average.

The chart shows the many of the 500 companies in the S&P 500 have exceeded expectations for quarterly earnings. Over 80% of the companies have performed better than expected in the current reporting season. There is no sign of a coming recession. Such a sharp increase usually only occurred at the end of a recession. Was that it already? Is there no more inflation at all?

A reliable indicator of an economic slowdown is the sale of heavy vehicles. Companies only invest in new trucks if they are confident that they will be able to amortize them in the future. Last month, truck sales did not fall as expected, but rose by 24%.
So the economic numbers are still very contradictory. An economy that is doing well is actually good news. But for a stock market that expects interest rates to fall quickly, poison. If the economy is doing so well, inflation will continue to rise and central banks will have to keep raising interest rates. Therefore, currently good numbers for the economy, bad for the stock market.