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Month: March 2023

Market Update Monday 27th March 2023

Banking sector turmoil continues

Uncertainty amongst investors continued following the fallout of SVB last week. The most pressing news came from Switzerland, where on Sunday, Swiss authorities approved the takeover of Credit Suisse by UBS for $2bn. However, as part of the deal, $17bn worth of Credit Suisse additional tier 1 (AT1) bonds, a type of higher-risk bank debt designed to take losses during a crisis, was wiped out by the Swiss financial regulator FINMA. That triggered a sell-off in AT1 bonds at other financial institutions on Monday, as investors began to worry that bondholders would have to take on bigger losses than shareholders.

Other market regulators distanced themselves from the decision, fearful that it would endanger banks’ ability to raise capital in the future. In addition, broader statements of support for the financial sector were made from European Central Bank president, Christine Lagarde, to US Treasury secretary Janet Yellen who signaled the government would back all deposits at smaller US banks if needed.

The slight improvement in sentiment meant that overall, as of 12pm London time, the US market finished higher by 0.82% with the technology index up 1.35%. European gains were minimal as markets have begun to fall again on Friday, led by Deutsche Bank which at time of writing has fallen 13.5% after a surge in the cost of its debt insurance. The UK and European index returned just 0.21% and 0.44% over the week respectively. The Hong Kong index finished up 2.03% whilst the Australian market was one of the few outliers, falling 0.57%, weighed by its real estate sector. Japan also finished lower by 0.21%.

All eyes on the Federal Reserve

Investors’ attention was also firmly focused on monetary policy decisions made on Wednesday as there was heightened speculation over whether the banking sector problems would be enough to cause the Federal Reserve (Fed) to pause. Ultimately the central bank decided to lift rates by 0.25% to a range of 4.75% to 5%. Despite the rate rise, markets were briefly lifted by the accompanying committee statement which removed references for the need of “ongoing” rate rises.

As a result, interest rate-sensitive 2-year Treasuries rallied on the day. As of 12pm London time, its yield which moves inversely to price fell 26 basis points over the week to trade at 3.57%. The 10-year US Treasury also rallied over the week, with its yield falling 14bps to 3.29%. Equivalent 10-year German bunds and UK Gilts also rallied, trading at 2.02% and 3.15% respectively.

UK inflation unexpectedly rises

UK inflation came in higher than expected with the annual rate of consumer price inflation rising 10.4% in February, up from 10.1% in January and higher than the 9.9% forecast by economists. According to the Office of National Statistics, the rise was driven by food and non-alcoholic drink, citing shortages in vegetable items given the high energy costs and bad weather across parts of Europe. As widely expected by market participants, the day after the release of the inflation data, the Bank of England Monetary Policy Committee voted to raise interest rates again, by 0.25% to 4.25%. The committee however kept its options open on whether further rate rises would be required.

Market Update Monday 20th March 2023

Financial authorities step in to stem fears of contagion in the banking sector

Whilst it has been another volatile week in markets, swift action by financial authorities following the collapse of the US bank, Silicon Valley Bank (SVB), last Friday, calmed nerves sufficiently to prevent a deeper loss of confidence in the banking sector. Authorities pledged to protect both insured and uninsured depositors (deposits over $250,000 are uninsured by the US Federal Deposit Insurance Corporation). During the week further banks came under pressure, including First Republic Bank, a US regional bank, and Credit Suisse in Europe. As a show of confidence, several large US banks deposited $30bn of cash into First Republic Bank, providing a large liquidity cushion. Whilst, following a plea from Credit Suisse, the Swiss National Bank said it would step in and offer liquidity support.

SVB has shone a light on the bond portfolios of banks which have suffered sharp losses as rates have increased. However, SVB’s case was somewhat unique in that as a bank to technology start-up company, it had grown very quickly in recent years and had invested a large proportion of its assets in very low yielding and long maturity bonds during the low inflation years. This came back to bite it hard as uninsured depositors lost confidence and began to withdraw their money, forcing SVB to realise its mark to market losses on its bond portfolio.

ECB raises rates by 0.5%, whilst expectations for future US hikes moderate

Despite the turmoil in the banking sector, the ECB still raised rates by 0.5%, citing inflation remaining at levels that are too high and expected to remain so for too long. However, expectations as to the next rate hike in the US moderated, with markets now pricing in either a rate hike of 0.25% or a pause. US inflation data for February was released this week coming in line with estimates, as inflation for the month of February came in at 0.4%, versus 0.5% in January. However, excluding food and energy, it rose by 0.1% to 0.5%. For the year, inflation now stands at 6.0%, versus 6.4% last month, still substantially higher than the Fed’s target of 2.0%.

As of 12pm on Friday, London time, US equities rallied by 2.6% over the week, whilst technology stocks jumped up by 5.2%. However, in Europe, where the banking sector suffered rolling contagion throughout the week, equities fell by 2.8%. The UK market, with a high weighting to financials fell by 4.2%. Similarly, Japanese stocks dropped by 3.6% and the Australian market lost 2.1%. Emerging markets fell by a relatively modest 1.5%, with Chinese stocks rising by 0.6%.

Haven government bonds rallied, with the yield, which moves inversely to price, falling to 3.5% on 10-year US Treasuries, 2.2% on German bunds and 3.3% on UK gilts.

Gold, a haven asset duration periods of distress, rallied by 3.9%, now trading at $1,958 an ounce. Whilst industrial commodities sold off on heightened concerns for global growth. Copper fell by 3.8%, now trading at $8,508, whilst Brent crude fell by 9.7%, now priced at $74.8 a barrel, and US WTI (West Texas Intermediate) falling 10.4% to $68.7.

Issues under discussion

Memories of the 2008 financial crisis

Whilst the stresses in the banking sector bring back memories of the 2008 financial crisis, this time around we believe that the recent bank failures are far less likely to trigger a global banking crisis. In 2008, much of the excesses built up in financial markets had their roots in property markets, funded by large amounts of cheap debt financing flowing into property securities. This time around, the excesses have been concentrated in niche equity segments and alternative asset markets funded by venture capital. As venture capital tends to be equity funded, when these companies fail, the loss typically ends with the investor, rather than being transmitted through to the financial system as a bad debt. Additionally, bank balance sheets as a result of the financial crisis, are much stronger today. Therefore, although the sharp rise in rates has caused some short-term losses for the banking industry, banks are in a much better position to weather the storm. This has been further reinforced by a decisive and rapid response from regulators to provide confidence to both insured and uninsured depositors.

Market Update Monday 13th March 2023

The Fed threatens to reaccelerate rate increases if inflation persists, sending markets southwards

Last week was volatile for equities and bonds ahead of the latest employment data which released on Friday.  Earlier last week Jerome Powell, chair of the US Federal Reserve (Fed) said they would be prepared to reaccelerate the pace of interest rate increases if the economy and inflation failed to cool. US Treasuries sold off with the yield on the 10-year US Treasury touching 4.01%, having been as low as 3.34% earlier in February, whilst 2-year Treasury yields exceeded 5% for the first time since 2007. The inversion of treasury yields, whereby shorter dated Treasury yields exceed those of longer dated bonds, and considered a harbinger to an impending recession, increased to over 1%. Banks, which hold large reserves of bonds on their balance sheets, were hit particularly badly, as rising bond yields reduce the value of those bonds.  The canary in the coal mine appeared as a small US bank, Silicon Valley Bank, announcing a share sale to reinforce its capital base. The US non-farm payrolls employment data released, forecasting 225,000 new jobs to have been created in February.  However, January’s forecast of 189,000 new jobs was blown wide apart with 517,000 new jobs having been created, making investors particularly jittery ahead of figures being released.

As of 12pm on Friday, London time, US equities fell 3.2% over the week, with US technology stocks falling by 3.0%. European stocks were down by 2.0% and UK equities dropped by 2.6%. Despite falling sharply at the end of the week, the Japanese market managed to hold onto gains of 0.6%, whilst Australian stocks fell by 1.9%. Emerging markets dropped by 2.0% with China being a large contributor, with domestic ‘A’ shares falling by 3.0% and offshore Hong Kong stocks dropping by 6.1%. Bullishness in the Chinese equity market has cooled in recent weeks as the rhetoric between itself and the US has escalated, whilst following the relaxation of covid restrictions, China has also not attempted to boost their economic recovery through monetary loosening, instead relying on Chinese consumers to do the heavy lifting.

German and UK government bond yields followed those of the US, rising earlier in the week before bonds rallied towards the end of the week as a wave of risk aversion swept over markets. 10-year German bunds are currently trading at a yield of 2.53% and gilts at 3.70%.

Gold dropped by 0.8%, now trading at $1,840 an ounce, whilst the risk of rising bond yields reducing global demand led to crude oil falling by over 5%, with Brent crude now trading at $80.9 a barrel and US WTI (West Texas Intermediate) $75.0.

Issues under discussion

US Treasuries inverted

US Treasuries inverted by the most in forty-two years, whereby shorter dated bond yields trade at higher levels than longer dated bonds, considered an indicator of an impending recession. Two-year Treasury yields, which move inversely to price, rose to 4.88%, versus the 10-year trading close to 4.00%. It was a similar story for European bonds, where 10-year yields rose to 2.74%, with two-year bond yields rising by a similar amount, to a yield of 3.22%. However, in the UK, whilst 10-year bond yields rose to 3.9%, 2-year bonds rallied, with the yield falling to trade beneath 10-year yields at 3.72%. The switch from yield inversion to yield steepening is normally a signal by bond markets that a recession is going to hit sooner rather than later, as markets start to price in rate cuts. However, on this occasion, this reaction to gilt prices may have been triggered by comments from Andrew Bailey, the Bank of England’s governor, who suggested on Wednesday that investors were wrong to assume many more rate rises were needed to tame inflation.

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