An Airport or a Lecture ?
Talks about dedolarisation and its consequences remained topical last week and besides the price action that saw currencies continue to grind higher, voices started to emerge in the US public arena about the risks that it might entail (including for the US). L. Summers who attended the IMF Spring meeting had opportunity to “feel the room” and reflected about it in his weekly interview to Bloomberg and week end’s Tweets:
“I do think in many ways the most profound question for American foreign policy, and it’s one that very much implicates economic policy, is that as right and just as we feel we are, there are just a large number of countries that are not aligned with us or that are only weakly aligned with us.
I heard a comment from somebody in a developing country who said, “Look, I like your values better than I like China’s. But the truth is, when we’re engaged with the Chinese, we get an airport. And when we’re engaged with you guys, we get a lecture.”
Big monetary transitions start with a drop, a ripple, a wave and end with a tsunami. We are well past the stage of the ripple with France, India, Saudi Arabia, Japan, Mexico, Brazil and many more suddenly hedging and looking beyond the US for economic cooperation and stability. Voices of discontent got louder and they kept coming from the very top of countries voicing their concern about the US bullying and how they plan to respond and organize around it, notably by building new alliances with China (but not only).
Unfortunately, only rarely did monetary transitions occur peacefully in history and it is no coincidence that the geopolitical scene is getting hotter by the day.
This is what Hank Paulson, US Treasury secretary during the 2008 financial crisis and probably the most decisive actor in the GFC resolution, seems to be most concerned about (in addition to his expectations that the aftershocks of the US banking “mad March” are still to be felt).
“The US-China relationship is on the brink. Communications have ground to a halt. There’s a lot going on in the world that’s troubling but to me it’s the US-China relationship that is the most worrying.”, he said.
Pressures remained on the regional banks with flows to money market funds continuing last week albeit at a decelerating pace. The FT also featured an interesting article about the Schwab’s business model (based on zero cost trading commissions ….and zero rates paid on billions of clients’ deposits, some of which are now looking for better alternatives) which might need to be revised.
Interestingly, JPMorgan which published better than expected results on Friday, giving its share price a 7% boost, largely benefited from the March chaos …. but to the best of our knowledge JPM does not pay for deposits either…which means that the current system is, as always, giving a considerable advantage to the “too big to fail” participant and without too much merit.
In relation to moral hazard it may have spurred, the FHLB system remained under fire for loans made to now-collapsed financial institutions Silicon Valley Bank, Signature Bank and Silvergate. FHLB loans come with favourable interest rates due to implied US government guarantee with critics arguing that the FHLB system which is extensively being used now (to avoid the stigma of relying on the discount window or other Fed backstop liquidity programs to pop up banks’ liquidity) has been encouraging risky behaviour by financial firms. FHLB banks are not alone in having opening the liquidity spigots as GSE Assets increased by an annual record $921bn last year to $9.224tn.
“The global finance system’s top regulator urged officials to ‘learn lessons’ from the recent banking turmoil, saying the latest stresses were a reminder that financial stability is ‘not merely an abstract concept’. Klaas Knot, chair of the Financial Stability Board, wrote that the need to tighten rules in response to the panic was ‘all the greater’ because, unlike other recent shocks to the global economy, such as the war in Ukraine and the coronavirus pandemic, ‘this latest episode had its origins within the financial system’.
Elsewhere on the economic front, the US published better than expected CPI and PPI reports last week which gave some confidence to equity markets that the Fed ‘s tightening campaign is nearly complete (expectations remain for a last 25bps tightening in May) and about to give way to a pivot. With the issue of the debt ceiling still unresolved, the U.S. government also recorded a $378bn (vs. $302bn expected) budget deficit in March, up 65% from a year earlier, as expenses outpaced revenues, bringing YTD fiscal deficit to $1.1trn. This compared to a budget deficit of $193bn in the same month last year… with unadjusted outlays increasing to $691 billion, up 36% from the same month last year.
Public debt is higher and growing faster than projected before the COVID-19 pandemic, driven by the US and China, the world's two largest economies, the International Monetary Fund's top fiscal expert noted.
The combination of more favourable inflation data and a ballooning deficit all by itself (not even considering pending banking problems) made a swift and firm turn in monetary policy all the more likely.
The IMF warned of a ‘perilous combination of vulnerabilities’ in financial markets, saying participants' failing to adequately prepare for interest rate increases has led to significant uncertainty about the health of the financial system. The IMF also said that US regional banks in particular may warrant closer scrutiny following the largest bank collapses since the GFC, four weeks ago, exposed weaknesses in the sector.
Turning to the market action, stocks gained further, the dollar dropped, precious metals rallied (until Thursday when gold flirted with its old time high vs. USD) and European bonds were hit hard with German bunds (and oat’s and btp’s) rising 30bps on the week. Bitcoin ripped higher for the whole week. The bond market reaction was more muted in the US where 10-year Treasury yields only increased by 5 bps while equity investors embraced the perspective of an upcoming pivot at the same time as they suffered from the FOMO syndrome with equities also squeezing, supported by elevated short equity hedge funds exposure.
Bloomberg reported that “Bonds tied to commercial mortgages (with USD1.5trn coming due by the end of 2025) are getting punished as money managers fret that US regional bank blowups will cut the availability of credit… Risk premiums, or spreads, on the highest-rated commercial mortgage bonds averaged about 1.12 percentage point, the widest since the early part of the pandemic and before then, near the highest level since 2016.”
“More US small businesses reported having greater difficulty getting a loan in March after multiple bank failures led to a further tightening of credit conditions.”, Bloomberg also reported. “A net 9% of owners who borrow frequently said financing was harder to get compared to three months earlier, the most since December 2012.”
Elsewhere in China, China's exports unexpectedly surged in March. Exports in March shot up 14.8% from a year ago, snapping five straight months of declines and stunning economists who predicted a 7.0% fall… Imports dropped just 1.4%, smaller than the 5.0% decline forecast and a 10.2% contraction in the previous two months.”
Over the past week, the S&P500 gained 0,8% (7,9% YTD) while the Nasdaq100 gained 0,2% (19,6% YTD). The US small cap index gained 1,5% (1,2% YTD). AAPL gained 0,3% (27,2%).
Cboe Volatility Index sold off by -7,2% (-21,2% YTD) to 17,07.
The Eurostoxx50 rallied 2,2% (16,6%), outperforming the S&P500 by 1,4%.
Diversified EM equities (VWO) gained 0,4% (4,3%), outperforming the S&P500 by -0,4%.
The Dollar DXY Index (UUP) measuring the USD performance vs. other G7 currencies dropped -0,2% (-0,5%) while the MSCI EM currency index (measuring the performance of EM currencies vs. the USD) gained 0,6% (2,3%).
10Y US Treasuries underperformed with yields rising 12bps (-36bps) to 3,51%. 10Y Bunds climbed 26bps (-13bps, Z-score 2,0) to 2,44%.10Y Italian BTPs underperformed (by 1 bp) rising 27bps (-42bps, Z-score 2,2) to 4,30%, underperforming Bunds by 1bps.
US High Yield (HY) Average Spread over Treasuries dropped -31bps (-23bps) to 4,46%. US Investment Grade Average OAS dropped -4bps (2bps) to 1,45%.
In European credit markets, EUR 5Y Senior Financial Spread dropped -9bps (-4bps) to 0,95%.
Gold dropped -0,2% (9,9%) while Silver gained 1,5% (5,8%). Major Gold Mines (GDX) gained 1,9% (22,4%).
Goldman Sachs Commodity Index gained 1,4% (-2,4%). WTI Crude rallied 2,3% (2,8%).
Overnight in Asia…
S&P500 +4 points; Nikkei -0.1%; CSI300 +0.9%
Asian equities were mixed and US and European share futures rose slightly in a cautious start to trading today.
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Overnight in Asia...
- S&P500 -1points; Nikkei -1%; CSI300 +0.1%, Hang Seng -2.5%
- HSBC led declines in Hong Kong as worries over risky bond exposures related to Credit Suisse spurred further risk-off.
- Overnight, central banks currently offering U.S. dollar operations have agreed to increase the frequency of 7-day maturity operations from weekly to daily. The network of swap lines among these central banks is a set of available standing facilities and serves as an important liquidity backstop to ease strains in global funding markets.
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Marc Bentin serves as Economic Advisor to Blue Lotus Management,
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