Michael Zezas: A New Dynamic for U.S. Banking

Investors’ renewed concerns around the banking system should have a variety of impacts on fixed-income investment.

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Welcome to Thoughts on the Market. I'm Michael Zezas, Global Head of Fixed Income Research for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about the intersection between public policy and financial markets. It's Thursday, March 16th at 11 a.m. in New York.

It's a volatile moment in markets, with investors grappling with complicated questions around the failure of Silicon Valley Bank. That event has naturally led to concerns about broader challenges to the banking system and potential impacts to the path for monetary policy. Here's what we think fixed income investors need to know in the near-term.

Our banking analysts and economists have concluded that the U.S. banking system is more constrained. The causes of the Silicon Valley Bank situation will likely cause banks and their regulators to think differently about capital, causing lending growth to decline more than expected this year. That, in turn, should put pressure on the labor market and therefore the general U.S. economic outlook.

We expect this dynamic will influence the U.S. bond market in the following ways in the near-term. For treasuries, we believe yields will be biased lower, because while the data still shows inflation pressures have persisted, that may take a backseat to financial stability concerns in the minds of investors. For corporate credit, there may be some near-term underperformance, given the market features a heavy weighting towards bonds issued by U.S. banks. In MUNI's, our team doesn't expect them to outperform in the near-term as the kind of interest rate volatility caused by recent events historically has been a headwind to the asset class. But a bright spot might be agency mortgage bonds, where our colleagues see room for compression in yields relative to treasuries. Those levels, which are near COVID crisis levels, perhaps overcompensate for fears that banks may have to sell their portfolios of similar bonds.

So that's what's going on in the near-term, but my colleagues and I will be back here frequently to give you some longer term perspective.

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