Monday morning Asia saw sharp falls in banking stocks following the news that $17Bln of Credit Suisse’s AT1 bonds would be written off, with investors suffering a total loss. Whilst this type of capital is designed to act as a cushion and absorb losses when a bank gets into difficulty, it was still a surprise when the announcement was made Sunday night. The Hang Seng fell 3.4% as HSBC and Standard Chartered fell 7% in reaction to the news.
So, what do we know?
(A forex, index and commodity market review)
The Federal Reserve, in its capacity as the US central bank and with responsibility for regulating the banking sector, took what it thought was decisive action by putting the Silicon Valley Bank, SVB as its known, into administration. In a follow up the Federal Reserve then confirmed that all depositors would get all their money back. A bank failure but not as far as depositors were concerned.
Signature Bank in New York quickly followed the same path while another regional Californian bank, First Republic bank, was caught up in the cross hairs of investors looking for the same exposure and risk that caused the SVB failure. The fact that First Republic has to borrow up to $100 Bln from the Federal Reserve as First Republic’s customers rushed to withdraw funds. Last Thursday the market seemed to calm down from the frenetic activity in both banking shares and in the US Treasury market, following the news that a group of top tier banks, lead by JP Morgan, were depositing $30 Bln into First Republic.
Sadly that did not stop the concern that the banking sector was significantly exposed to losses on unhedged bond portfolios following the rapid increase in interest rates by the Federal Reserve. Despite the improvement in bank’s balance sheets since the great financial crisis, it seems there are a number of banks that have been poorly run and have significant unrealised losses on their portfolio of bonds.
Using SVB as an example, this bank had $180 Bln in deposits from various tech firms in California. These types of deposits were cheap funding for the bank but could be withdrawn at any time depending on the terms. The problem was that SVB invested these deposits into long-term Treasuries, which a year or so ago provided better returns. The BIG problem though was that these bond portfolios were unhedged and when interest rates went up last year, bonds collapsed as inflation surged. And the other leg of the trade, well depositors have been rushing to withdraw their deposits leaving the bank with disastrous losses on its bond portfolios.
By Friday’s close, First Republic’s shares had fallen 33% for a total fall of 72% on the week as investors highlighted their concern about contagion in the banking sector. To underline such concerns, the ratings agency Moody last Tuesday cut its rating on the whole US bank sector to negative from stable.
The mood soured further in Europe, where banking stocks fell again dragging the FTSE100 sharply lower due to the number of large banks making up the index, including Europe’s largest bank HSBC. Credit Suisse has had many years of scandals and setbacks and quickly became a target of investors concern, as its largest investor ruled out any further support. Last week the Swiss National Bank was announced the provision of $54 Bln of liquidity to help Credit Suisse. This did not help the bank much as investors were rushing for the exit. Towards the close of last week the cost of insuring against Credit Suisse defaulting on its debt had escalated, reflecting investor’s lack of support in the bank. The provision of liquidity was never going to stabilise the bank and by Friday night, the Swiss National Bank announced that it was effectively brokering a deal for UBS to acquire Credit Suisse. At the time of writing it appears that a deal has been reached where UBS will acquire Credit Suisse but at a far lower price that where the stock closed last Friday afternoon. The Saudi National Bank and the Qatar Investment Authority invested SFr3bn into Credit Suisse as part of a raising of SFr4bn just a few months ago. How quickly circumstances change.
Weekly change (amount change and percentage change on the week)
FTSE -412 -5.33%
DAX -659 -4.28%
DOW -47 -0.15%
S&P +55 +1.43%
NASDQ +491 +4.41%
NIKKEI -776 -2.78%
Hang Seng -67 -0.34%
US indices recovered some of their losses from the previous week although, as discussed, the banking sector continues to worry investors. The investors angst over the banking sector has resulted in a further flight to safety into US Treasuries (US sovereign bonds – much lower risk than equities) where yields on the critical 2 and 10 year bonds tumbled in very hectic volatile trade as bond prices surged. The fall in short-term bond yields was so dramatic that yields fell the most in one day since 1987 as traders and investors rush to the safe haven of bonds in the expectation now that the Federal Reserve will hold back in further rates rises over the coming months.
The CPI data last week poses a dilemma for the federal Reserve now, as inflation clearly remains more sticky than thought just 2 months ago. But the banking crisis has severely dampened down expectations of further rate significant rises. This week there is now a 62% probability of a 0.25% hike in rates whilst many, including Goldman Sachs expect the FED to keep rates on hold. Just a week ago the Fed was expected to raise rates by 0.5%. Further out, the FED is expected to cut rates towards the end of the year with year end rates looking at 4%. A week ago, this expectation was at 5.25%. A very fluid situation which may not be clarified much this week either.
The ECB, despite the unfolding banking crisis, stuck to its guns and raised rates by 0.5% as expected. Some thought the bank might only raise rates by 0.25% but the view was that this banking crisis was more of a US issue. Two days later it seems a lot closer to home with Credit Suisse falling to its much larger Swiss rival.
EURUSD +0.25 +0.24%
GBPUSD +1.42 +1.18%
USDJPY -3.22 -2.38%
Forex markets reflected the shift in US interest rate expectations as the US dollar fell against almost all majors. The EURO versus the USD remained little changed on the week following the ECB policy announcement last Thursday. Despite raising rates by 0.5%, the bank delivered a more dovish message as it stated that it would give no further guidance and said any further moves would be data dependent. The ECB said it was monitoring the banking sector issues and would respond if banking stability was threatened. The reading of the ECB statement is that the bank will likely not rise rates if the banking crisis persists but would likely resume its process of raising rates to return inflation to the targeted long-term level of 2%.
Sterling rallied against the US Dollar as traders still expect the MPC to deliver a 0.25% interest rate rise although some analysts think the MPC might pause whilst the banking crisis unfolds.
Gold +121 +6.48%
UK OIL -10.15 -12.28%
US OIL -10.29 -13.43%
Gold surged last week in a classic flight to safety, in a similar fashion to the moves the in the Bond markets. Gold surged on Friday reaching close to the $2,000 level which was last hit in April 2022and no far from its all time high.
Oil was crushed last week, and is till being crushed, as it tracks the path of global economic activity. Not only did crude oil suffer on the back of the slump in equities and the flight to safety over the past week but data out of China does not suggest that the Chinese economy is yet responding as well as the optimists had hoped following the removal of the Zero Covid policy.
What don’t we know….yet?
(What traders need to look out for in the week ahead)
A very busy calendar this week and a key week for markets with the US Federal Reserve announcing its latest rate rise, or not, with an update on future rate moves. We also have the Bank of England where investors will be keen to know what effects the banking crisis has had on the outlook for interest rates in the UK.
What’s not in the calendar is the unfolding banking crisis where bad news seems to roll into bad news. On Monday morning the European markets will have to deal with the news over the weekend of the rescue of Credit Suisse by UBs and the surprise move to right off $17Bln of Credit Suisse’s AT1 Bonds.
No data of any consequence
Germany ZEW economic sentiment. This number has been improving – the banking crisis headlines will likely dent sentiment.
UK CPI. Inflation data. Will be keenly watched ahead of MPC rate decision on Thursday. Another small decline to 9.9% as the rises from last year are yet to be taken out the annual calculation. Expect an acceleration in the fall in inflation as crude oil continues to tumble in the wake of the banking crisis. GBP and UK assets sensitive.
Eurozone Lagarde from ECB speaking ECB and Its Watchers conference, in Frankfurt.
US FOMC. Key event of the week. Will the Fed raise rates by 0.25% or keep rates on hold in the wake of the ructions in the banking sector. Efforts by banking regulators in the developed world seemed to have failed so far to put out the fire. Look out for future guidance in the statement and press conference. USD, US and global equity and bonds all sensitive to this data.
Switzerland SNB monetary policy meeting. An increase of 0.5% in interest rates as the SNB grapples with inflation. CHF sensitive.
UK MPC monetary policy meeting. Odds are even for a 0.25% hike in interest rates, or the bank keeps rates on hold. Depends on the trajectory of the banking crisis but recent data painted a more robust UK economy than many economists expected. GBP & UK assets sensitive.
UK, EU & US Flash manufacturing and services PMI data. A slight improvement in last months data. The manufacturing sector being the sector worst hit by the rapid rise in rates over the past year or so.
What should we be trading?
(Analysis of the popular markets and what we like)
In today’s Podcast Adrian delivers a brief review of the FTSE100, Gold and the Nasdaq index.
What’s the problem?
(Examining a problem many traders face and what to do about it)
This week’s problem is trade sizing. When markets are more volatile stop losses naturally become wider, and traders need the flexibility to reduce their stake per point accordingly. With many spread betting providers implementing high minimum stakes per point this can create a problem. Traders are forced to place the trade with increased monetary risk or avoid the trade altogether. In this section, Adrian explains how it all works and what you can do about it to take control of your risk management and trade sizing, even in more volatile markets.