April 3, 2023 | 2 MIN READ

Weekly Market Update

Inflation, Jobs, and Banks

What happened last week?

  • The S&P 500 gained 3.48%
  • The Dow Jones rose 3.22%
  • The Nasdaq composite increased 3.37%

This week, the market will focus on Friday’s jobs report. The economic community is calling for 238K jobs to have been created in March with an unchanged unemployment rate of 3.6%. Average hourly earnings gains are expected to slow.

If correct, this will help put downward pressure on inflation. The list of firms announcing layoffs has been growing and we expect the list to swell further in the weeks and months ahead as firms try to rein in their costs.

3 Things to Know

Fast action to support banks

The unexpected events of the past month have focused investors on the risks to bank earnings and the financial sector’s equity and preferred securities’ values. We remain neutral on expected bank common equity performance and expect the sector to remain volatile, but we do not foresee another financial crisis and view this tail risk as small.

Regulators in the US and elsewhere acted quickly to reassure investors that the banking sector is sound, and they continue to be proactive. The evening of the Silicon Valley Bank failure, for example, the Federal Reserve created a new program to provide liquidity to banks called the Bank Term Funding Program.

This facility allows banks to pledge high quality Treasury and agency mortgage-backed securities (MBS) as collateral to the Fed for a period of up to one year, and in return receive cash up to the full “face value” of the pledged securities.

US bank preferreds are generally understood to rank junior to all the debt of the bank issuer.

A key consideration for preferred valuation within this capital structure context is that dividends cannot be paid on a bank’s equity unless the bank first pays the coupon (or dividend) on its preferred security. If there’s any dividend payment at all, the full amount owed on the preferred must be paid.

Notably in the US, among the 10 largest banks (plus one large brokerage services company) going back to the year 2000, only one bank didn’t pay a dividend for a period of time and it was during the depths of the Great Financial Crisis (GFC).

Bank preferreds — regardless of rating of the actual security — are generally issued by investment-grade rated issuers.

Most bank preferreds don’t have maturity dates, meaning they’re “perpetual” unless called by the issuer. Therefore, “extension risk” exists when a preferred security doesn’t get called on its initial call date.

What happened in the preferred market

In US markets, investment-grade-rated preferred index yields had soared 100 basis points following the Silicon Valley Bank failure to 7.9%, exceeding levels reached last November.

While even the large money center banks saw certain preferred yields rise above 8.0%, the underperformance was largely led by regional bank issuers. Yields now are approximately 7.35%.

Cautious investor sentiment also fueled a meaningful flight to quality into US Treasury debt. In turn, the yield premium (or spread) offered in the investment grade (IG) preferred market pushed significantly wider.

Index spreads in IG-rated preferreds are now roughly 355 basis points, the widest levels since the peak Covid selloff.

Citi Global Wealth Investments
Charlie Reinhard - Head of North America Investment Strategy
Lorraine Schmitt - North America Investment Strategy

See our weekly CIO Strategy Bulletin for more details