Wednesday Mar 15 2023 11:05
9 min
Just like that, it all looks like the banking crisis is contained, right? The truth is we don’t really know what is lurking out there in terms of liquidity risk after the sharp selloff in the stock prices of some of regional US banks in particular – as we saw in ’08 declining bank share prices can impact liquidity and funding, becoming a self-fulfilling spiral. I don’t think we are at that stage at all. Moody’s cut its outlook on the US banking system to negative, citing ‘rapidly deteriorating operating environment’. Stocks rose though – led by Wall Street but also the likes of First Republic, which rallied 27%. KRE the regional bank ETF, jumped 2% but was well off the highs of the day by the close and is still down 22% in the last five sessions. Western Alliance Bancorporation, another caught in the firestorm, rallied 14% but is down 58% since the selling broke. FRC is 65% lower. The Fed is looking at tougher rules for mid-sized banks in the wake of all this – not surprise and only confirms thesis that regulatory clampdown will raise costs just as they need to start paying a heck of a lot more for deposits. Should regulatory oversight be stricter – the whole point in ditching some rules was to make them more competitive, to drive growth. It’s a fine balancing act – but no other bank seems to have been so badly exposed to interest rate risk.
US inflation rose in line with expectations and although bond yields rose off the lows of the week the market came around to the idea that the Fed will be a bit less hawkish and that with the banking problem thus far contained, is good news for stocks. Growth predictably picked up the most bid with the Nasdaq up 2% to 11,428, whilst the Dow trailed with a gain of 1% to 32,155. The move saw the Nasdaq recapture its 200-day simple moving average at 11,401. The S&P 500 split the difference, rising 1.65% to recapture 3,919, ten points short of its 200-day SMA.
European stock markets posted solid gains on Tuesday as they too bounced back from Monday’s wobble. This morning we are seeing a bit more caution with risks still unknown, and the ECB meeting ahead on Thursday to consider. Euro Stoxx banks slid by around half of one percent at the open. The FTSE 100 retreated half a percent to 7,600 dead, sitting 5% off its 8,000 high. Similar losses were registered in Frankfurt and Paris in early trading, but this was after a strong rally on Tuesday.
The US 10yr note yield advanced to 3.707%, coming off lows below 3.5% struck earlier in the week amid a broad flight to safety on these US bank worries. Whilst higher yields is usually bad for stocks (or has been lately) the dynamic is difference in wake of the SVB collapse and the huge move in bond markets we saw in its wake. Repricing higher yields is good news as bonds are offered and markets are showing less fear. Lower yields have seen the dollar index repeatedly test the 103 mark but this is holding for now. ECB tomorrow with 50bps still on the table creates further risks. Gold has pushed lower for a second day, retreating further from its more than one month high at $1,914 as yields recovered with the 10yr TIPS up more than 20bps from its Monday lows, rallying from 1.20% to 1.40%. Bitcoin smashed through key resistance around $25,200 to rally above $26k before paring gains back to just under $25k this morning – the move though opens path to $28k if confirmed. Rejection suggests $23k at the 50-day line before big round number support at $20k.
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Consumer prices in the US rose 0.4% for the month, taking the annual rate of inflation to 6%, according to the US Labor Department. These were in line with forecasts. Core CPI increased 0.5% in February and 5.5% on a 12-month basis – slightly ahead of forecasts. The CPI suggests we could see 12-month core PCE inflation – the Fed’s preferred gauge – accelerate to 4.8% from 4.7%. With this report the Fed would normally be a slam dunk to raise rates by 25bps though markets have been questioning this in the wake of the bank crisis: I don’t think the Fed blinks unless we see a lot more turmoil. The combined market cap of the failed banks was only about $20bn...it’s not a major deal in of itself.
We are now firmly into the discussions about what the Fed calls ‘long and variable lags’ of monetary policy. No one has quite been sure when the lagging effect of rate hikes will start to bite – we have the answer at least in part with SVB. But as for the wider economy, it’s less clear – the labour market remains in decent shape for now. The Fed will go for 25bps – to pause now would suggest they were afraid, and it would shred their inflation fighting credentials. To pause would shout to markets “don’t worry team, the Fed put is back” - that would be real moral hazard.
Couple of ticks from my preview last week: already we know the Treasury says that energy bill support will continue until the end of June, as I’d outlined was likely – limited duration and cost now – an easy win. The other tick was the pre-announcement of a short-term multi-billion-pound bung to the Armed Forces- but now major new commitment on spending.
The 10yr gilt yield sits around 3.5% this morning having bounced off lows of 3.25% earlier this week – mirroring the moves in global fixed-income markets. The 2yr is almost identical – looking to see if we get some move here in terms of expectations for how high the Bank of England goes – already seeing markets sharply dial back their expectations for hikes this year and what the Chancellor says today will have implications for rates. GBPUSD steady at $1.2150 this morning and EURGBP well anchored in the middle of its long-term range at 0.8830. I don’t really see any major moves in sterling since the Chancellor seems likely to play it safe and is not going expansionary all of a sudden. Stock sectors to watch – oil & gas (windfall, biz investment), banks (SVB + windfall), hospitality (tax breaks, energy support), housebuilders (it’s the Tories, there is always something for home buyers).
The main risk is actually to the upside funnily enough – that there is way more money for businesses than we’d thought – boost for banks, domestic focused stocks (FTSE 250 + banks + housebuilders). We’ve been kind of down on Chairman Hunt, but you never know, he might have a five-year plan for growth after all…
Here’s some more from my preview last week:
TLDR: Things might a little less glum than many had feared as the economy is proving a bit more resilient and energy prices have come down, but don’t expect many fireworks or giveaways from Chairman Hunt.
Resilient – It looks as though the Chancellor can hail the public finances being in much better condition than he or the OBR figured they would be in November. Lower energy costs are a big factor, reducing the cost to the government of the Energy Price Guarantee. Households have kept spending and tax takes have been good. Lower market-based interest rates have also helped to cap mortgage costs – albeit the full effect of this on household finances will only be felt as 1m+ fixes come due in the coming months.
Bond vigilantes – Gilt yields have moved back up in recent months following the mini-Budget spike. Largely we can trace the UK yield alongside international peers amid a global selloff in bonds in February. However, as the mini-Budget revealed, bond vigilantes cannot be discounted entirely – albeit the trauma in the gilt market was in large part thanks to LDI market mechanics that have subsequently been sorted. Given the Chancellor’s fiscal conservatism, I see limited risk of any serious reaction in gilts. Lower expected borrowing will be a positive for gilts, and ultimately the direction will be determined by the global fixed income market, not the UK chancellor.
Fiscal drag – the Chancellor will continue to rely on the effects of the fiscal drag. Tax receipts have ballooned thanks to frozen thresholds on things like capital gains, personal income and inheritance tax. For instance, self-assessment income tax receipts hit almost £22bn in January, up a third in a year. But don’t expect the Chancellor to review thresholds even as the squeezed middle becomes even more likely to squeak – this is too valuable an earner for the Treasury and avoids the more unpopular cut-and-hike cycle to tax rates. Moreover, a high tax burden will be seen as a useful way to rein in inflation – monetary and fiscal policy working in tandem. Or as Lenin put it: "The way to crush the bourgeoisie is to grind them between the millstones of taxation and inflation." Chairman Hunt knows the script.
Biz investment – Business investment in the UK has been woeful since Brexit. Labour is drawing up plans to review the entire business tax regime in a bid to boost investment and growth. Shadow chancellor Rachel Reeves – chancellor in waiting many would say – announced plans on Tuesday (March 7th) that could force the incumbent into changes, albeit any such changes would be tinkering at the edges of the problem. Maybe expect some limited tax breaks for capital investment but the Treasury cannot afford more.
No relief for big business – despite calls for the chancellor to scrap a planned corporation tax hike, Mr Hunt will almost certainly press ahead with the planned increase in the rate larger companies pay from 19% to 25%. Investment incentives are also ending with the corporation tax super-deduction, which allows businesses to reduce their tax bill by 25p for every £1 that they invest, will also end. As per the above, the chancellor might extend this scheme to boost investment, but it has been incredibly costly to the Treasury. Instead, less costly and limited tax breaks are possible.
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