No Hike Won't Hurt …
Updated: Mar 21
Last week alone, the Fed put back on its balance sheet some USD303bn, split evenly between the use of the discount window (emergency fed lending) and the use of the new credit facility put in place last Sunday (Bank Term Funding Program or BTFP) to ease the pressure off regional banks by allowing them to pledge previously “held till maturity” bonds in a bridge loan facility (with par lending value).
In addition to the spiraling down of First Republic (a regional bank), most of last week was spent witnessing the fallout of Credit Suisse amidst mounting evidence it was suffering further liquidity stress (and depositors’ withdrawals), leading to more liquidity backstops extended by the SNB in support of the bank.
Last week, the inversion of the yield curve was abruptly reduced as short-term bonds outperformed by the biggest margin ever, causing heavy losses on momentum traders betting on further inversion and additional yield increases, just as US and European bond yields posted their biggest rallies in decades (2Y US yields dropped 75bps on the week). Commodity Traders also had to extricate themselves from USD300bn of wrong-way bets in their space (with 2/3d of this position unwound in three days according to JPMorgan). This led Quant momentum funds to shed 7% on the week.
Despite this turmoil, US equity markets managed to eke out some gains for the week, led by the Nasdaq which was itself supported by lower bond yields, the pricing of a (forced) Fed pivot, and the belief after the Fed/FDIC bailout of depositors from SVB, that financial pressures will ease.
Over this past weekend, rumors amplified of a forced tie-up between UBS and CS which crystalized on Sunday and was announced by the President of the Swiss Confederation, A. Bierset, during a joint press conference attended by Federal Council member K. Keller-Sutter in charge of the Federal department of finance and the Heads of the SNB, the FNMA, CS, and UBS who outlined the historic merger (and essentially “take down”) of Credit Suisse by its larger Swiss rival UBS in a Swiss only solution aimed at preserving the reputation and integrity of the Swiss financial place.
The details of the deal were announced in a communiqué and extensively presented during the press conference:
UBS will buy CS for USD3bn, accompanied by a Swiss Government CHF9bn guarantee for potential losses on assets acquired by UBS with the SNB offering a liquidity backstop of CHF100bn and with AT1 bonds being “bailed in” (wiped out). In consideration of the unique circumstances affecting the Swiss economy as a whole, the Swiss Federal Council issued an emergency ordinance (Notverordnung) tailored to this particular transaction, allowing the merger to be implemented without the otherwise necessary approval of the shareholders of UBS and Credit Suisse.
The Fed will be meeting this week in a high-tension context where it will be caught between the hammer of having to fight inflation and the hard place of addressing a banking crisis. With the yield curve steepening by 60bps in a couple of days, something it has only done a few times in history and which is also the bond market’s way of saying recession risks are now more elevated, the Fed is more likely to pause than further tighten in our view.
Last week, the ECB tightened rates by 50bps, citing lingering inflation pressures in a move that will likely be the last one as well, as long as the financial stress does not recede.
The week end’s events will contribute to easing tensions but the ongoing turmoil may still continue to linger for several reasons:
First, the extent of potential liquidity problems at regional banks could be far from over (once Silvergate, SVB, and First Republic are taken out) as they represent roughly 50% of the US banking system with each of them operating under a regulatory “light” format (Banks with less than USD250bn are not submitted to liquidity and stress tests, unlike larger banks like JPM, Citi, etc…), potentially exposing them to similar mismatch issues as their unfortunate and already taken down peers.
The financial disintermediation of deposits might continue on safety and return-seeking grounds. Depositors are now balking at the remuneration offered by regional banks (often still close to zero) which are way lower than market rates (and close to the historic and unhedged yield of “held to maturity bonds”). The more appealing alternative (until the Fed could be forced to cut rates drastically) will remain to buy safer T-bills or money market funds remunerating themselves with reverse repo rates lodged at the Fed at near market rates. The USD30bn that larger US systemic banks were asked to redeposit last week into regional banks (after being withdrawn from depositors) will by definition, considering the sheer size of regional banks, not cover the balance sheet size reduction forced upon regional banks unless confidence returns and the yield offered by them justify it.
So far, the crisis has not involved “credit risk” (only the markdown of “held to maturity” treasuries). However, regional banks are granting 80% of the commercial real estate loans (the weakest real estate segment) and 50% of credit card debts which might get degraded as the recession takes hold. They also provide financing to “private equity” which is not regularly marked to market.
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Over the past week, the S&P500 gained 1,1% (2,0% YTD) while the Nasdaq100 rallied 5,8% (14,7% YTD). The US small cap index sold off by -2,8% (-1,8% YTD). AAPL rallied 4,4% (19,3%).
Cboe Volatility Index rallied 2,9% (17,7% YTD) to 25,51.
The Eurostoxx50 sold off by -3,9% (7,6%), underperforming the S&P500 by-4,9%.
Diversified EM equities (VWO) dropped -1,0% (-0,6%), underperforming the S&P500 by-2,0%.
The Dollar DXY Index (UUP) measuring the USD performance vs. other G7 currencies dropped -0,5% (1,4%) while the MSCI EM currency index (measuring the performance of EM currencies vs. the USD) gained 0,5% (0,9%).
10Y US Treasuries rallied -27bps (-45bps, Z-score -2,2) to 3,43%. 10Y Bunds dropped -40bps (-46bps, Z-score -2,2) to 2,11%. 10Y Italian BTPs rallied -27bps (-66bps, Z-score -2,2) to 4,05%, underperforming Bunds by 13bps.
US High Yield (HY) Average Spread over Treasuries climbed 59bps (40bps) to 5,09%. US Investment Grade Average OAS climbed 14bps (22bps) to 1,65%.
In European credit markets, EUR 5Y Senior Financial Spread climbed 37bps (29bps, Z-score 2,3) to 1,29%.
Gold rallied 6,5% (9,1%, Z-score 2,8) while Silver rallied 10,0% (-5,6%, Z-score 2,1). Major Gold Mines (GDX) rallied 12,4% (6,7%, Z-score 2,5). Bitcoin surged even more, adding 34% on the week…to 28’000.
Goldman Sachs Commodity Index sold off by -6,0% (-11,4%, Z-score -2,1). WTI Crude sold off by -13,0% (-16,8%, Z-score -2,3). Goldman dropped its price target of 100 for the next 12 months ahead, saying the banking crisis and economic risks now outweigh additional demand from the reopening of China.
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,
a specialist multi-manager investment firm, which seeks to provide investors a compelling alternative to the traditional 60/40 equity and bond portfolio by targeting higher returns without amplifying equity risks.
BentinPartner GmbH is Advisor to the Phi Funds AIF, an umbrella Alternative Investment Fund registered and regulated in Lichtenstein, specializing in the management of Funds focused on physical precious metals.
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