Observation Deck: Nothing is certain but uncertainty


SVB Asset Management's monthly Observation Deck newsletter covers current topics on portfolio management, credit considerations and market events that influence investment strategy. 

Nothing is certain but uncertainty

Fiona Nguyen, Senior Credit Risk & Research Officer

As Britain inches toward the Brexit finish line, global markets continue to be plagued by heightened uncertainty. This lack of confidence has become a major roadblock weighing on the markets and near-term economic activity. The risk of a no-deal still lingers, even as the European Union (EU) has agreed to a two-week extension, delaying the deadline to April 12. After Parliament repeatedly rejected the withdrawal agreement brought forth by Prime Minister Theresa May, she must now scramble to gather enough support to get a revised Brexit deal passed by the House of Commons. In the event the vote falls through yet again (i.e., no agreement between May and the House of Commons), May will need to petition the EU for a longer extension to avoid a “hard exit” on April 12. While any extension will ease the immediate threat, it does not eliminate the risk of serious market disruptions. It is clear that a prolonged uncertainty will dampen investor sentiment, increase the operating costs for businesses in the regions and further weaken the UK’s economic outlook. 

Brexit is not the only uncertainty on investors’ minds. Recessionary concerns loom large overseas as Chinese economic data paint a bleak global outlook. China reported the steepest year-over-year decline in exports in three years. On top of that, factory output — an indicator of manufacturing health — also slowed to a record low amidst weak domestic demand as a result of China’s planned deleveraging efforts and elevated trade tariffs. These disappointing economic prints followed a similar weakening trend in European and other Asian markets, as discussed in March’s Observation Deck. It is likely that the weak trade data all share the same root cause: the US-China trade dispute that continues to disrupt global supply chains and erode growth prospects everywhere.

Given the Brexit turmoil and elevated trade tensions between the US and China, central bankers around the world seem to agree that global economic growth is at risk. This was illustrated by the Federal Open Market Committee’s (FOMC’s) most recent decision to hold interest rates unchanged at its March meeting. The FOMC revised its interest rate outlook for no additional rate hikes in 2019 (versus the two rate hikes that were projected in December). It also planned to phase out the reduction of its balance sheet by this September. Both actions markedly pivot the Federal Reserve’s stance toward monetary easing and further reiterate the “patient” approach. A more accommodating monetary policy was also echoed by the European Central Bank (ECB), which has embarked on a new stimulus program in the form of cheap funding to European banks. Meanwhile, the Bank of England and Bank of Canada have also maintained rates steady at current levels. Needless to say, the concerted dovish tone in monetary actions aims to counter rising risks of an economic slowdown.

Thus, as the first quarter came to a close, there were obvious negative undertones to the market. Unless lawmakers can avert the Brexit turmoil and otherwise resolve global trade disputes, corporate investments and trade activity will likely be subdued, further escalating the global deterioration. Likewise, market participants will continue to seek safe haven or keep on the sideline until clarity returns.

As we are at a critical juncture of this business cycle, it is important to stay disciplined in managing credit selection and duration while maintaining a balanced approach. Staying diligent and building resiliency with high quality credits provide us the flexibility to respond to a potential downturn.

Economic Vista: A soft patch or something more?

Jose Sevilla, Senior Portfolio Manager

The US economy is in its 10th consecutive year of growth, yet it is still not displaying typical late-cycle characteristics of high inflation or high interest rates. We are starting to see wages accelerate in response to a tighter labor market, and consumers continue to spend at a solid rate. However, the Federal Reserve signaled a pause in raising interest rates for 2019, and some of the other recent data is suggesting that the US economy may be slowing. Is this just another first quarter soft patch, or is it something more?

While job growth had been on an unprecedented run, there was a deceleration. US employers added 20,000 jobs in February, which was the smallest monthly job growth since September 2017 and far below consensus expectations for an increase of 180,000 new jobs. Despite weak job creation, the unemployment rate fell to 3.8 percent, while the labor-force participation rate remained at 63.2 percent. And although hiring fell short of expectations, wage growth surprised to the upside. Average hourly earnings have been consistently stronger for the past several months, and in the most recent month, wages jumped a better-than-expected 3.4 percent year-over-year.

Partially offsetting the underwhelming jobs data was a rebound in the retail sales report, which was delayed due to the government shutdown. After falling 1.6 percent in December, headline retail sales rose 0.2 percent in January. Excluding food, gas and autos, the so-called “retail control group”, which is widely considered a cleaner gauge of consumer demand, rose 1.1 percent. The report eased concerns about consumer spending after a surprisingly weak December report that was likely affected by the government shutdown and seasonal factors.

On the inflation front, US consumer prices continued to decelerate as the February Consumer Price Index (CPI) declined to 1.5 percent, down from 1.6 percent in January. The year-over-year slowdown was driven by a sharp slide in energy prices at the end of 2018. Meanwhile, core CPI slowed to 2.1 percent year-over-year, which is down nominally from January. 

Fourth quarter gross domestic product (GDP) was revised from 2.6 percent initially to 2.2 percent. The revisions largely reflect weakening consumption, moderating growth and low inflation. Despite the lower revision, this keeps the overall US economic growth pace at just above 3 percent for 2018. Core personal consumption expenditures (PCE) still remain below the FOMC's 2 percent target, coming in at 1.8 percent in the fourth quarter of 2018. The report indicates that the US economy was affected by mounting concerns over trade, geopolitical headwinds and slowing growth in Europe and China. Not surprisingly, the Fed has taken notice.

As widely expected, the FOMC kept interest rates unchanged at its March meeting. What was surprising, however, was that the committee was unexpectedly dovish. There was a strong consensus for zero rate hikes for the remainder of 2019 and only one in 2020. The committee wrote: “With core PCE inflation running consistently below 2.0 percent in recent periods, the Fed has had little need to be aggressive.” Fed officials also announced the end of the balance sheet reduction, capping the runoff to $15 billion from $30 billion. The balance sheet reduction will end by September. In its press conference, Fed Chairman Jerome Powell said the US economy is “in a good place” and indicated that the Fed will use its monetary tools to keep it there. However, Powell and his colleagues also acknowledged that “recent developments both domestically and abroad were making it harder for the US economy to grow as quickly as it did last year.” Although the markets initially cheered the Fed’s interest rate decision, there are questions as to whether the domestic economy is experiencing a seasonal sputtering or something more.

Credit Vista: Bank on it!

Melina Hadiwono, CFA, Head of Credit Research

As the current US economic expansion is the second longest on record, US banks roll on with strong financial results. Despite market volatility stemming from fears of a global growth slowdown and a flattening yield curve, performance during the fourth quarter of 2018 continued to reflect solid operating results, healthy capital levels and strong asset quality. It’s no surprise that profits continued to improve, thanks in part to the gradual rising interest rates and positive operating leverage. According to the FDIC’s Quarterly Banking Profile, the aggregate net profit for the fourth quarter of 2018 was $59 billion for 5,406 insured institutions, an increase of more than 133 percent compared to a year ago. This was almost 19 percent higher, excluding the impact of tax reform. Full year 2018 net income rose by more than 44 percent from 2017 to $236 billion, with an increase of more than 13 percent from 2017 when excluding the impact of tax reform.


The banking sector posted a healthy loan growth of 4.4 percent led by commercial, industrial and consumer loans, and the growth outlook is moderately positive going forward. Net interest income was 8.1 percent higher compared to a year ago, mostly due to growth in interest-bearing assets and a wider net interest margin that affected more than 82 percent of all domestic banks. Net interest margin rose 17 basis points (bps) to nearly 3.5 percent, thanks to average funding costs that grew less than average asset yields.

Total deposits increased 2.2 percent in the fourth quarter of 2018 from the previous quarter, which is the largest quarterly dollar increase since the fourth quarter of 2012. This reflects a continued rise in interest-bearing deposits that more than offset any decline in non-interest-bearing deposits. Going forward, greater price sensitivity among depositors will continue to narrow the incremental benefit to banks’ net interest margin. Thus, any further earnings improvement will likely come from loan volume growth rather than net interest margin expansion, which looks to be more modest since the rising rate cycle may have run its course for the near term.

2018 ended with asset quality remaining solid with the nonperforming loan balances (90 days or more past due) dipping to 0.99 percent, the lowest since second quarter 2007 and down 3 bps from the previous quarter. The total net charge-off ratio also reached a historically low level despite slightly higher credit card net charge-offs.

Looking ahead, the Fed’s rate pause could further extend the current impressive period of strong asset quality, thanks to incremental relief on borrowers’ costs. Tier 1 capital ratio continued to hover at a record high of 13.2 percent, though we would not be surprised if it declined slightly if either shareholder payouts or loan growth were to accelerate. The number of banks on the FDIC’s “Problem Bank List” declined to 60 from 71 at year-end 2018, which is the fewest since first quarter 2007. All these metrics confirm the relative health of the financial sector and that US banks are comfortably positioned to withstand any potential weakening of credit conditions.

Trading Vista: Course correction

Jason Graveley, Fixed Income Trader

What a difference one quarter can make. In December, the Federal Open Market Committee (FOMC) decided to raise the federal funds target for the fourth time in 2018, while also revising its Dot Plot to reflect expectations for two additional rate increases in 2019. Today, the outlook has changed dramatically, and the Federal Reserve has altered course. In the March FOMC announcement, the Dot Plot was further revised to reflect zero rate increases in 2019. The Fed is now charting a much flatter rate path over the next several years, and the markets have reacted in kind, with Treasury yields inverting between the 3-month Treasury bill and 10-year Treasury note. It appears that investors have become less optimistic about the economy, recognizing a strong labor market but also acknowledging potential headwinds that could affect global growth and trade.

Overall, credit spreads have tightened, and yields have dropped considerably from much wider levels seen in December. The Bloomberg Barclays Short-Term Credit Index, an index that tracks the performance of investment grade corporate debt maturing in less than one year, has tightened close to 40 percent year-to-date. A separate index that tracks one- to three-year maturities has tightened similarly. And corporate bonds aren’t the only security type feeling the squeeze. The start of 2019 has been an ideal funding environment for commercial paper (CP) issuers. With a light slate of expected maturities and capitulatory buying from large money market funds, the spread between term-dated CP has evaporated as 3-month tenors trade mostly in line with their 9-month counterparts. Across the spectrum, this rate movement has compressed credit spreads and increased the relative value of Treasuries. As a result, we continue to emphasize selectivity in credit while increasing overall Treasury allocations in client portfolios.


Treasury Rates: Total Returns:
3-Month 2.38% ML 3-Month Treasury 0.20%
6-Month 2.42% ML 6-Month Treasury 0.23%
1-Year 2.39% ML 12-Month Treasury 0.35%
2-Year 2.26% S&P 500 1.24%
3-Year 2.21% Nasdaq 1.85%
5-Year 2.23%    
7-Year 2.31%    
10-Year 2.41%    

Source: Bloomberg, Silicon Valley Bank as of 3/31/19


The views expressed in this column are solely those of the author and do not reflect the views of SVB Financial Group, or Silicon Valley Bank, or any of its affiliates. Views expressed are as of the date of these articles and subject to change. This material, including without limitation the statistical information herein, is provided for informational purposes only. The material is based in part upon information from third-party sources that we believe to be reliable, but which has not been independently verified by us and, as such, we do not represent that the information is accurate or complete. This information should not be viewed as tax, investment, legal or other advice nor is it to be relied on in making an investment or other decision. You should obtain relevant and specific professional advice before making any investment decision. Nothing relating to the material should be construed as a solicitation, offer or recommendation to acquire or dispose of any investment or to engage in any other transaction.

None of the material, nor its content, nor any copy of it, may be altered in any way, transmitted to, copied or distributed to any other party, without the prior express written permission of SVB Asset Management.

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About the Author

Fiona Nguyen is a senior credit risk and research officer at SVB Asset Management (SAM). In her role, she conducts fixed income research and issuer recommendations for the financials sector. Fiona has over nine years of credit risk, financial modeling and investment research experience across a variety of sectors, notably financials and telecom equipment. Passionate about corporate finance and capital markets, Fiona enjoys connecting all the dots and assessing the impacts to these industries.

Prior to joining SAM, Fiona served as a senior associate at JPMorgan Asset Management in New York where she actively managed counterparty exposures across various financial products, including plain vanilla securities, structured products, FX and derivatives. Before her time with JPMorgan, Fiona held various research roles at Mizuho Americas, State Street Bank & Trust and CIFC Asset Management. Fiona began her career at ANZ Banking Group in institutional banking where she received her credit training. Fiona earned a master’s degree in Business Administration from Northeastern University and a bachelor’s degree in Finance from California State University, Sacramento. She is currently undergoing the Chartered Financial Analyst (CFA) designation process. Having completed Level II, she is now a Level III candidate.

Part of her adventurous nature, Fiona loves exploring life in different cities. During the past 10 years she has lived in five different metropolitan areas and thoroughly enjoyed the charms of each. Outside of work, she can be found spending time with her newfound interest – her daughter, watching international soccer and practicing photography.