Has the Banking Sector Stabilized? We’ll Know More in a Few Weeks

There was some more favorable deposit data last week, but is it enough to get the all-clear?

It’s been less than a month since three U.S. banks went down, and Credit Suisse was forced into an acquisition after the bank looked to be on the brink of failure. Now, investors are wondering if the worst is in the rearview mirror. There have been some signs of stabilization, including more favorable data. Things have also been quieter, and First Republic, despite experiencing significant deposit outflows, seems to be hanging on — not that the bank has an easy path forward. While things certainly could be stabilizing, I think we’re going to learn a lot more over the next few weeks. Here’s why.

Deposit data

One piece of data that investors have been watching closely is how deposits across the banking system are trending, which the Federal Reserve releases in its H.8 report every Friday. Because higher interest rates have customers seeking out yield in safer assets, and because the Federal Reserve has been pulling liquidity out of the economy through quantitative tightening, deposits in the banking system have been on the decline and contributed to problems that ultimately brought down Signature Bank and SVB Financial. Deposits are the lifeblood of the banking system, so in order to feel better about the sector, the market is going to want to see deposits stabilize. In last Friday’s H.8 data, which is for the week ending March 22, commercial banks in the U.S. experienced a decline of roughly $126 billion in deposits on a seasonally adjusted basis. Digging in deeper, the top 25 largest commercial banks chartered in the U.S. saw a decline in deposits of about $90 billion after seeing inflows of about $67 billion during the week ended March 15. Meanwhile, deposits of small U.S. chartered banks inched up about $6 billion. That’s certainly good news, but it turns out that the outflows experienced by smaller banks in the week ending March 15 were much greater than anticipated, roughly $196 billion. It’s still a bit hard to say what will happen. Historically deposits have repriced higher on a lag, which seems to be what’s happening now, but the Fed’s interest rate hikes have been so much more intense than anything seen in the past that it’s hard to know exactly what to expect from deposit behavior. Investors will be closely watching this upcoming Friday’s H.8 data. Plus, bank earnings will kick off next week, with many of the super regional banks reporting the week of April 17. Investors and analysts will be anxious to hear from bank management teams about deposit behavior among their customers.

Inflation data

Rising interest rates have become a big problem for banks, not only because they are leading to deposit outflows but also because they have put many bank bond portfolios underwater. Underwater bond portfolios and deposit outflows have turned into a lethal combination. That’s why inflation data is so important. The Fed needs to know that it has won its war with inflation, which would allow it to end its aggressive rate-hiking campaign. While it takes time for rate hikes to work their way through the economy, the Fed hasn’t seen data showing that it’s winning its war with inflation. The U.S. economy added more than 800,000 jobs in January and February, and the unemployment rate remains at 3.6%. The Fed wants to see more cracks because it believes the historically tight labor market is contributing to inflation. Meanwhile, the Consumer Price Index (CPI), which tracks the prices on a market basket of consumer goods and services and is a closely watched gauge of inflation by the market, was still up 6% year over year in February. That’s progress, to be sure, but the Fed’s target for inflation is 2%, so there is still work to do. Certain items in the CPI, like shelter costs, are still growing too fast, so the Fed would like to see a slowdown there as well. The March jobs report comes out on April 7, and the March CPI data comes out on April 12. If the data is still inconclusive or shows a lack of progress on the inflation front, the Fed could raise interest rates again at its next meeting, which would not be good for the banking sector.

Still in a holding pattern

While there has been some encouraging data, I still think investors are operating in the unknown right now when it comes to the banking crisis. More time and data are needed to know if conditions have truly stabilized and where the banking sector is currently at, but we should learn a lot over the next few weeks. While the uncertainty makes investing difficult, I believe there are many good long-term buying opportunities out there among bank stocks that investors can take advantage of. But with so much still unknown, it might be best to start with a smaller position and then build gradually or act accordingly as more data becomes available.