The weather is changing for the markets

A little over two months later, how is 2023 shaping up in the financial markets? Bank of America sums it up nicely with a (unfortunately anonymous) quote from an investor: “It’s like watching a rabid donkey thrash about in a field, bouncing off all the fences.”

If anything, it might be a bit cruel to the rabid donkeys, although to be honest they were baffled, at least in part, by a factor no one could have predicted: the weather.

US Federal Reserve Chairman Jay Powell admitted the same this week. Beginning his annual speech to Congress on Tuesday, he spoke about economic conditions and noted that the data for the first months of 2023 were optimistic.

“Employment, consumer spending, manufacturing output and inflation have partially reversed the softening trends we saw in the data just a month ago,” he said, adding that “part of the change likely reflects unseasonably warm weather in January in most parts of the country. ”.

This helped put higher US interest rates back on the agenda, hitting bond prices again. Mother Nature, of course, is not entirely responsible here, but her influence on the Fed’s likely path is significant.

Data for January showed that the US economy added more than half a million jobs. February figures released on Friday showed that he added 311,000 immediately afterwards. The rise in the unemployment rate in February will likely be enough to persuade the Fed to raise rates in small rather than large increments, but its job of tightening policy is clearly far from over nonetheless.

The smart money has always known that the weather matters to the markets. It is no coincidence that in 2018 Ken Griffin’s hedge fund Citadel accumulated a team of 20 scientists and analysts to make weather forecasts. This world-class know-how helped Citadel earn up to $8 billion in bets on gas, electricity and other commodity markets last year alone, part of the fund’s staggering 38% return in 2022.

This is an extreme example. But the weather has been a market driver that is now popping up in conversations with fund managers more than ever, I can remember, especially with regards to the unusually mild period that helped Europe avoid nasty recession fuel bills compared to the past. year. winter

Robert Dischner, senior portfolio manager on Neuberger Berman’s multi-industry fixed income team, doesn’t spend his days studying the squiggles on weather maps. “We don’t have a team of meteorologists,” he says. “But we are paying attention. I have a graph of gas and electricity prices on the screen.”

It all ties into the single biggest driver of every asset class in the post-pandemic lockdown. “We need to understand what this means for headline inflation?

“Twenty-five percent of the gilt market is driven by inflation, so that matters,” Dischner said. His colleague Simon Matthews, who specializes in high-yield corporate debt, said the weather and its impact on fuel costs are key to his assessment of default risks among risky companies. “Energy was one of the most important topics that the company management talked about last year,” he says. “If you fail to hedge your energy properly, it will have a significant impact on you. [earnings]”.

Now that we no longer have the rising tide of easy money lifting all boats in the credit markets, this type of company-specific strategy is much more important.

The weather-related impact on interest rates also hit broader markets this week through a different channel when California Bank of Silicon Valley, a small technology-focused lender suffered heavy losses related to its US Treasury holdings and was shut down by regulators.

A carefree market that felt the Fed had its back would probably have brushed SVB’s troubles off for what they were: SVB’s problems were rooted in the SVB’s business model. Instead, we faced a sell-off in bank stocks in the US and then in Europe, fueled by the notion that other much larger banks could face similar difficulties if they cut the value of their bonds on their books.

Fund managers almost universally agree that the narrative is grossly overblown.

SVB was small, with “a very concentrated deposit base,” says Kiaran Callaghan, head of European capital research at Amundi. He was “unprepared for an outflow of deposits, had no liquidity on hand to repay deposits, and was therefore a forced bond seller, which led to an increase in capital and created contagion. It’s a very isolated, idiosyncratic case.”

But the constant bouncing in the bond market right now shows that the mood is “shy,” says Craig Inches, head of rates and cash at Royal London Asset Management.

Weather maps can’t tell you when and when a tech-heavy provincial bank in the US will stumble, although some lavishly paid hedge fund meteorologists might try to figure it out. But all of this is a reminder that any secondary factors, such as technical oddities or bizarrely warm winters, can really affect a market that is in suspense about what the Fed will do next.

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