Two and a bit months in, how is 2023 shaping up in financial markets? Bank of America sums it up well with a (sadly anonymised) quote from an investor: “Like watching a mad donkey thrashing around in a field bouncing off all the fences.”
If anything, this may be a little harsh on mad donkeys, although in fairness, they have been thrown off their stride at least in part by a factor that nobody could have predicted: the weather.
US Federal Reserve chair Jay Powell acknowledged as much this week. Kicking off his annual testimony to Congress on Tuesday, he set the scene on economic conditions and noted that data from the opening months of 2023 has been upbeat.
“Employment, consumer spending, manufacturing production and inflation have partly reversed the softening trends that we had seen in the data just a month ago,” he said, adding that “some of this reversal likely reflects the unseasonably warm weather in January in much of the country”.
This helped to put the notion of higher-for-longer US interest rates back on the agenda, dealing a new blow to bond prices. Mother Nature is not entirely responsible here, of course, but her impact on the likely path forward for the Fed is substantial.
January’s data showed that the US economy added more than half a million jobs. February’s numbers, released on Friday, showed it added 311,000 straight afterwards. A pickup in the unemployment rate in February will probably be enough to convince the Fed to raise rates in smaller rather than larger steps, but still, its job of tightening policy is clearly nowhere near done.
The smart money has always known that weather matters to markets. It is no coincidence that in 2018, Ken Griffin’s Citadel hedge fund has amassed a 20-strong team of scientists and analysts to make weather forecasts. That world-class knowhow helped Citadel make as much as $8bn out of bets on gas and power and other commodity markets last year alone, part of the fund’s eye-popping 38 per cent gains in 2022.
This is an extreme example. But the weather has become a market-moving factor that pops up in conversation with fund managers more frequently now than at any other time I can recall, particularly regarding the unusually mild spell that helped Europe to dodge a nasty recession-inducing fuel bill over the winter.
Robert Dishner, senior portfolio manager on the multi sector fixed income team at Neuberger Berman, is not spending his days poring over squiggly lines on weather maps. “We don’t have a team of meteorologists,” he says. “But we do pay attention. I have a chart on my screen of gas and electricity prices.”
It all plugs in to the single biggest driver of every asset class in the world in the aftermath of the pandemic lockdowns. “We have to understand, what does it mean for headline inflation?
“Twenty-five per cent of the gilts market is inflation-linked, so it matters,” Dishner said. His colleague Simon Matthews, who focuses on high-yield corporate debt, said weather, and its impact on fuel costs, are key to his assessment of default risks among risky companies. “Energy was one of the biggest themes that company management teams were talking about last year,” he says. “If you don’t get your energy hedging right, it’s a meaningful impact on your [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 bit in to broader markets this week through another channel, when California-based Silicon Valley Bank, a small, tech-focused lender, suffered a large loss relating to its holdings of US Treasury bonds and was closed by regulators.
A happy-go-lucky market that felt like the Fed had its back would probably brush off SVB’s woes for what they were: SVB’s problems were rooted in SVB’s business model. Instead, we ended up with a selloff in bank stocks across the US and later in Europe, feeding on the notion that other much bigger banks may face similar strains if they mark down the value of bonds on their books.
Fund managers almost universally agree that narrative is vastly overblown.
SVB was small, with a “very concentrated deposit base”, says Amundi’s head of European equity research, Ciaran Callaghan. It was “not prepared for deposit outflows, didn’t have the liquidity at hand to cover deposit redemptions, and consequently was a forced seller of bonds that drove an equity raising and created the contagion. This is very much an isolated, idiosyncratic case.”
But the constant whipsaw action in bond markets right now shows the mood is “skittish”, says Craig Inches, head of rates and cash at Royal London Asset Management.
The weather maps can’t tell you when and when a heavily tech-dependent US provincial bank will stumble, although some lavishly compensated meteorology nerds at hedge funds could try to figure it out. But this is all a reminder that any marginal factors such as technical curiosities or freakishly warm winters can really end up making a difference in a market on edge about what the Fed will do next.