A developing banking crisis caused volatility to spike in March, leading to a drop in short-term yields and new monetary policies to try and stabilise the market. The long end of the yield curve benefited from a flight to quality, while equity and credit markets were choppy but found support late in the month. The Australian bond market had a strong month and rose 3.16%, as measured by the Bloomberg AusBond Composite 0+ Yr Index.
Early in the month, the RBA raised the cash rate by 0.25% to 3.60%, indicating that more tightening was possible. However, the bank's tone was less hawkish than February's statement. Due to banking sector stress outside of Australia, there was a significant drop in yields which caused markets to rethink their views on monetary policy and growth. As a result, the AU3Y and AU10Y government bond yields fell by 66 bps and 55 bps to close the month at 2.94% and 3.30%, respectively.
Although offshore events dominated the headlines, the latest economic data showed that the economy grew by +0.5% in the December quarter– continuing growth. The NAB Business Survey, conducted over January and February, showed strong business conditions. The labour market rebounded significantly in February, showing a potential upswing in the March quarter. Inflation in Australia appears to have peaked towards the end of last year; the yearly rate in February was still well-above target rate at 6.8%.
Short-term interest rate futures traded in a wide range in March, resulting in markets transitioning from expecting further monetary tightening to now expecting a peak cash rate of 3.60% for this cycle. Futures markets are also pricing in the chance of a 0.25% cut in the cash rate by the end of the year. 90-day bank bill yields were slightly higher than the cash rate, ending at 3.72%, while 180-day bank bill yields reflected the change in monetary policy expectations, ending 14.5bps lower at 3.79%.
The banking crisis in the US spread quickly to Europe, affecting the credit markets as well. During a single weekend, three US regional banks collapsed and Credit Suisse had to be taken over by UBS, causing the most significant period of financial sector stress since the Global Financial Crisis. Although there was prompt regulatory and government intervention and support, certain debt and equity holders suffered significant losses.
Due to the fast rise of interest rates in recent months, traders and hedge funds are searching for and exploiting vulnerabilities, leaving investors uneasy and evaluating if this caution will lead to stricter lending standards, resulting in a credit crunch that could severely impact economic growth.
Capital markets experienced significant volatility in March due to the rapidly rising interest rate environment. Pressure on the banking system resulted in three regional banks closing down, Credit Suisse being taken over, government deposit guarantee plans being put in place, and the creation of a new lending facility for banks.
The stock market was largely mixed to close the month, but regional banks experienced the sharpest declines. The Regional Bank ETF (KRE) had its worst 3-day selloff since it began in 2006, dropping more than 27%. Its daily relative strength index (RSI), which measures momentum, reached a record low of 11.6. During this time, investors turned to safe investments like precious metals and large-cap growth, and defensive stocks. Small caps from almost all sectors (9 of 11) also had losses in March.
Volatility Index
Although there was significant volatility in certain areas of the stock market, particularly in banks, the VIX Index remained relatively stable. The index only reached a high of 26.52 in March and had three days where it closed above 25 before dropping below 19 at the end of the month.
US Equity Markets
In March, the Nasdaq 100 had the highest total return among major US indices at +9.5%. It had a great first quarter with a gain of +20.8%, its best since 2012. The S&P500 and Dow Jones Industrials also had strong monthly gains of +3.7% and +2.1%, respectively. The S&P 500 has gained +7.5% for the second consecutive quarter. Market statisticians have noted that historically if the S&P500 has gained more than +7% in Q1, it has never finished the full year lower. Out of the previous 23 instances of this occurring, there were two consecutive quarters where the gain exceeded +5%. One year later, the market finished higher 20 times with an average increase of +13.5%. However, the smaller cap S&P Midcap and Russell 2000 fell by 3.2% and 4.8%, respectively.
Equity Sector Performance
Sector performance differed significantly between large and small companies. Among the eleven sectors in the S&P 500, seven of the large-cap sectors showed growth, led by Technology and Communications. The Technology sector showed the most significant increase in Q1, mainly driven by the semiconductor industry, with the SOX Index having its most impressive quarter since June 2020 and its second-best quarter in 22 years. Utilities and Staples showed gains of +4.9% and +4.2%, respectively, while Financials declined by 9.6%. The Industrials sector is noteworthy since it is just under 3% away from 52-week highs.
US Interest Rates
The banking crisis caused a lot of volatility in the rates market. In March, the market was beginning to accept the Fed's plan of keeping rates high for a more extended period, but then suddenly changed its outlook and started to predict rate cuts as early as July. The November contract rate plummeted more than 185 basis points in only three trading sessions. Although rates have rebounded due to recent market stability and consistent inflation data, the chances of the first rate cut have been pushed back to September or November. Still, the situation could change quickly.
Oil Markets
Crude oil experienced a sharp drop in 2023, falling more than 16% YTD to its lowest point in 15 months. However, after a surge at the end of the month, it closed the month down only -1.8%. Oil markets jumped by around +8% over the weekend when OPEC+ made a surprise announcement of production cuts exceeding 1 million barrels of oil per day, led by Saudi Arabia with 500,000 barrels. The increase in energy prices is a problem not only for the Federal Reserve's efforts to control inflation but also for the Biden administration due to the fact that the Strategic Petroleum Reserve has decreased by 222 million barrels (from 594 million to 372 million) over the past 15 months since the start of 2022.
Precious Metals
The prices of precious metals increased, with spot gold and silver increasing by +7.8% and +15.2% YTD, respectively. Gold ended the month at $1,969, trading higher than its 2011 peak and only 6% away from reaching new all-time highs. In March, the US Dollar Index (DXY) dropped by -2.3%, marking its fifth decrease in the past six months.
The Months Ahead
The US Fed is facing a dilemma as stresses in the banking system have made it hard to balance price stability and financial stability. Recently, they increased rates by 25bp, making it a total of 19 rate hikes in the past year. Despite Chair Jerome Powell stating that the banking system is stable, he also mentioned that the committee is considering the real economic impact resulting from the stresses in the banking system through the lending channel. There is a 55% - 65% probability for a 25 basis point rate hike. However, there is increasing talk about the timing and speed of the Federal Reserve's rate cuts. According to their economic projections, they anticipate keeping rates around 5% until the end of 2023.