Crypto News: It's a See No Evil, Hear No Evil Economy Now

Let's start up where we left off last week, now that we've got some corporate earnings and the first inflation read in this more upbeat, new normal investing climate.

What I was saying then was that the risks were to the upside, toward good outcomes for the US economy. And that, in turn, should buoy stocks but be a bit of a headwind to bonds. What we've seen in the interim is that both stocks and bonds have done reasonably well, as inflation looks to be calming down. That's not only true in the US. We also saw low inflation figures in the UK on Wednesday. And so for now, the Fed's rate cuts will proceed apace, bolstering both stocks and bonds until the outlook changes — which of course it will.

A few points I want to get across:

The bank earnings have been good so far but that doesn't tell you enough about credit.
I liked what I saw from Charles Schwab though and that tells us more.
As for the path of interest rates, listen to what Atlanta Fed's Raphael Bostic says. It's not as dovish as traders have been pricing in.
It all adds up to a hear-no-evil see-no-evil investment climate in the near term. The risk remains inflation perking back up.

The most consequential earnings we've seen so far in the US this quarter have been from the big banks. And to a firm, they were above expectations, even the laggards.

Take Bank of America, for example. They are a bit of a problem child among big banks. If you recall, this is the big bank that suffered most from the problems that felled Silicon Valley Bank. BofA similarly exited the pandemic with a ton of long-term Treasury and mortgage-backed securities whose values were eviscerated when the Fed starting hiking interest rates. The bank would still lose $85 billion if it sold those government bonds at today's prices, more than quadruple what the larger JPMorgan Chase would give up. But that's less than half of around $200 billion it would have lost had it sold during the regional bank crisis a year a half ago.

Those low-yielding pandemic-era bonds are dwindling at about a $10 billion pace each quarter and getting replaced with higher-yielding assets. The result is over $14 billion in net interest income this quarter and next. Add to that the great results from investment banking and trading and an increase in loan balances and you've got net income of $6.9 billion. Per share that's down almost 12% from last year. But it's better than the 16% drop expected.

Wells Fargo, Goldman Sachs, Citigroup all beat expectations. A lot of that was based on trading and investment banking. Goldman, more tethered to that world, saw profits up 45%. But still, the plain vanilla banking side of things looks good at all the big banks, including BofA. But, of course, that's what you would expect in this bifurcated world of corporate haves and have-nots. It's the regional banks that we need to think about in terms of the overall health of the economy because they're more exposed to small businesses, a segment of the economy in a funk. And they're the ones who took a shellacking from the Fed's rate hikes when the value of their mortgage and Treasury portfolios sank.

On that score, Charles Schwab's results are telling because they were the non-regional financial institution that most mimicked the pandemic investment strategy of many regional banks who stuffed their money in long-term 'safe' assets. By every metric that matters regarding the regional bank crisis — earnings, funds staying at Schwab instead of seeking higher-yielding alternatives, a reduction in high-cost funding sources — Schwab beat expectations. Essentially, the root causes of that episode — a mismatch between low-yielding assets and the high cost of deposits in this higher-yielding world — are now over. The assets are higher yielding. And with the Fed now lowering rates, the threat of losing so many deposits seeking higher deposit rates that you have to sell assets (like Silicon Valley Bank did) is over.

We'll hear from the regional banks in due course. But I am expecting good things. And that means the regional bank-led credit crunch that many of us thought could have caused a recession is not a big issue anymore.

I know that's extrapolating a lot on the economy from the big banks. But I just look at this as further eliminating the risk of recession and increasing the chances of a soft landing.

If you're looking for guidance on where the Fed is headed, look no further than Atlanta Fed President Raphael Bostic, whose cautious views on inflation and concern about employment sort of set the guardrail limits on what the Fed is capable of doing. I would characterize him as someone still worried about inflation, but with enough concern about rising unemployment that he was convinced to approve a jumbo rate cut last month.

Just after the Fed did the jumbo cut, he gave a speech saying the following:

Not only did the Committee reduce the Fed's policy rate from the 5-1/4 to 5-1/2 percent range that we've held for just over a year, we also reduced the target by a full ½ percentage point. Though not a total surprise, this was a larger adjustment than some expected.
[...]
Specifically, in my judgment, we have made sufficient progress on inflation, and the labor market has exhibited enough cooling, that the time has come to shift the direction of monetary policy to better reflect the more balanced risks to our price stability and maximum employment mandates that have emerged over the course of the year.
In fact, progress on inflation and the cooling of the labor market have emerged much more quickly than I imagined at the beginning of the summer. In this moment, I envision normalizing monetary policy sooner than I thought would be appropriate even a few months ago.

Translation: inflation is low enough now to start cutting and the unemployment situation is alarming enough to do so quickly.

But Bostic followed this up after I wrote last week's piece. This outlines his current thinking and puts some limits on how quickly cuts are coming:

In new projections submitted at that meeting, Bostic penciled in one more quarter-point cut this year. "So that already signals that I'm open to not moving at one of the last two meetings if the data comes in as I expect," said Bostic, who is a voting member of the Fed's rate-setting committee this year.

I think this is very representative of the central tendency of the Fed. He's saying something like, "look, I backed the jumbo cut as a preventive measure. But, depending on how good the data are, I'm also comfortable following it up by skipping a cut here and there before we get down to a fed funds rate of 3% or so."'

That kind of thinking is very much in line with my baseline of 25 basis-point cuts at every meeting until we get to 3%. But if inflation is hotter or employment looks improved, they could skip a meeting. Conversely, I think the bar is high for another jumbo cut. This asymmetry means that long-term Treasury rates have a soft floor through which they're not likely to go. 4% is a good anchor now for investors who want to lock in yield but are also cognizant that they're unlikely to see a huge capital appreciation unless the economy falls apart.

For now then, things look pretty good. Forget about politics and geopolitical risk. Oil prices are going down anyway. And that helps both to keep inflation in check and to keep interest rates low, both of which are supportive of equities. And as long as the economy is doing well, equities will do well too. Next up are the megacap tech companies. How they fare will tell you a lot more about the outlook for S&P 500 earnings.

I'd be lying if I told you I don't have my worries about how long this can last. But I'm enjoying it while it does.

I didn't mention Morgan Stanley. But they beat too. Shares surged the most in 4 years too.
That downbeat orders announcement from ASML on Tuesday isn't related to AI. So, for now, the AI investment binge can carry on.
Though I gave sort shrift to politics, this tariff thing will matter. Here's a ground story view on how that plays out.

Do you expect a weak or a strong earnings season? Will financial results help the mega caps rally, or is it better to bet on smaller stocks for the rest of the year? Share your views in a short MLIV Pulse survey.

Like getting The Everything Risk? Check out these newsletters:

Markets Daily for what's moving in stocks, bonds, FX and commodities
Odd Lots for Joe Weisenthal and Tracy Alloway's newsletter on the newest market crazes
Economics Daily for what the changing landscape means for policymakers, investors and you
CFO Briefing for what finance leaders need to know

You have exclusive access to other subscriber-only newsletters. Explore all newsletters here to get most out of your Bloomberg subscription.

Bloomberg Markets Wrap: The latest on what's moving global markets. Tap to read.

Like getting this newsletter? There's more where that came from. Browse all our weekly and daily emails to get even more insights from your Bloomberg.com subscription.

Before it's here, it's on the Bloomberg Terminal. Find out more about how the Terminal delivers information and analysis that financial professionals can't find anywhere else. Learn more.

Want to sponsor this newsletter? Get in touch here.