Week in review

• ECB raised rates by 50bps
• U.S. February headline CPI logged 0.4% m/m and 6.0% y/y increase
• China industrial production rose 2.4% y/y; fixed asset investment by 5.5%; retail sales by 3.5%

Week ahead

• U.S. Fed policy decision
• UK CPI
• Japan core CPI

Thought of the week

With the recent banking failures, it is timely to remind ourselves of the duration mismatch built into the banking model -- banks borrow short in the form of deposits and lend long through loans or high quality bond holdings. This is why the U.S. Treasury yield curve matters, which has inverted since mid-2022, with the 2/10 spread reaching over 100bps inversion, unseen since 1980s. When funding costs exceed returns, it erodes bank interest margins and prompt the unwinding of carry trades. A prolonged inversion, while it did not directly cause the recent banking crisis, created a challenging environment where banks are more sensitive to bank runs. Going forward, with the fear of having to meet more deposit withdrawal needs, small- and medium-size banks might tighten credit standards. As these banks provide 40-50% of lending in the U.S., reduced lending could weigh on aggregate demand. This incident also sent the 2-year Treasury yield collapsing from over 5% after Powell’s testimony to 4.2% at the time of writing, reducing the 2/10 inversion. With heightened rate uncertainties and sentiments constantly fluctuating, yields will likely remain volatile in the next weeks, which is why in the short term, we suggest to remain short duration, before leaning more into duration after the sentiments and the market environment stabilizes.

The 2/10 U.S. Treasury spread was negative for more than 100bps before rebounding10-Year U.S. Treasury yield minus 2-Year U.S. Treasury yield (bps)

Source: Federal Reserve Bank of St. Louis, J.P. Morgan Asset Management. Data reflect most recently available as of 17/03/23.

0903c02a82467a72