The US financial sector was at the spotlight at the end of the week. It all started with the announcements by SVB (Silicon Valley Bank) that they will need to raise capital, after incurring large losses on their bond portfolios and after clients started withdrawing their deposits. This bank's clients are primarily start-up companies, which usually do not have profits or enough cash and rely on funding by venture capital funds or/and credit from banks. And these type of companies have been hurt the most by the rise in interest rates. Just one day later the bank was shut down by the authorities, as 40bn of its deposits had been requested to be withdrawn out of the total 200bn of deposits on Thursday alone. This is the second largest banking failure on record, second to Washington Mutual back in 2008. The news soon sparked panic among investors and depositors in similar, regional banks. The problem with banks is that even if there is no real issue, a rumor could lead depositors start withdrawing their deposits en masse, and then undoubtedly trouble will arrive. The situation warrants close monitoring, as we approach the 15th anniversary of the Bear Stearns collapse (16 March, 2008) which was the prelude to the financial crisis, which errupted 6 months later.
But authorities came to the rescue over the weekend, after a second bank was shut down. The FED , the FDIC and the Treasury issued on Sunday a joint statement with measures that would help all depositors have access to their cash balances, even those with higher amounts that the insured by the state. A special funding program was put in place to provide liquidity to banks who face increased wirthdrawals from clients. These announcements will certainly calm the markets at the open, but it is unclear if it will eliminate the fears and the danger.
Equities dropped hard, with US equities underperforming the rest of the world. The S&P500 finished the week almost 5% lower and Nasdaq did not escape (-4.5%) as the SVB failure could lead to big losses in the Technology companies who could have seen their cash balances at the bank being wiped out. Europe fared a bit better with 2% losses on average for the main indices.
Bonds had a volatile week, but finished on a very positive note, as "flight-to-safety" rippled through trading desks. The failure of the SVB bank creates the necessary conditions for the FED to proceed with cautiousness and the 50bp increase for next week which was priced in before the events now looks like a very remote probabiility. The US 10-year Treasury yield fell from a high of 4% to 3.70%, while the 2-year yield traded as low as 2.40%, down from 5.10% just a few days ago. The high quality and high duration bonds offer protection to investment portfolios in periods like that, of potential recession or another financial crisis.
The US labor market remains strong, according to the latest data released on Friday, but cracks begin to appear. The February non-farm payrolls rose by 311'000, an impressive number after the 500k+ of January. Of course we must mention that these data are the product of seasonal adjustments and a lot of "computer manipulation" to estimate them. Unemployment rose, however, to 3.6% as the participation rate increased, ie more people started looking for a job. This increase in labor supply is estimated at about 410'000 people which is higher than the 311k of new hires, which is considered dis-inflationary. Another positive aspect of the jobs report, from an inflation point of view, was the average hourly earnings which increased less than expected on a monthly basis (0.2% vs expectations for 0.4%). This means that there is no pressure on inflation from wages, as the annual change remained close to 4.5%, down from almost 6% a few months ago. However, the continuing jobless claims, i.e. the number of people who continue to receive unemployment benefits jumped to a new high of the last 15 months.
The FED's Chairman, Mr. Powell, decided to put his hawkish face on again. In contrast to the previous FED meeting when they had preannounced that the next rate increase will be back to the usual 25bp, Mr. Powell during his semi-annual testimony to the Congress, said that interest rates might have to rise more than anticipated and with a higher pace of increases. "Although inflation has been moderating in recent months, the process of getting inflation back down to 2 percent has a long way to go and is likely to be bumpy. As I mentioned, the latest economic data have come in stronger than expected, which suggests that the ultimate level of interest rates is likely to be higher than previously anticipated. If the totality of the data were to indicate that faster tightening is warranted, we would be prepared to increase the pace of rate hikes." . These were the exact words and the market was quick to assign a 65% probability to a 50bp hike next week. But the crisis in some US regional banks which errupted on Friday and the bloodbath on Wall street make these statements appear already outdated.
The ECB is prepared to raise interest rates by 50bp on Thursday. Despite the speculation at the start of the year that the ECB is contemplating slowing down the pace of interest rate increases, the recent communication by its senior officials, includings its President, are pointing to a 50bp increase again. Having toned down slightly the "aggressiveness" during the previous meeting's press conference compared to December, it would be interesting to see if Mrs. Lagarde will offer any new signals for the next meeting and/or make any comments on the "mini" US banking crisis.
China's inflation fell much more than expected. The CPI index for February dropped to 1.0%, down from 2.1% in January and vs expectations for 1.9%. Even more importantly the Producer Price Index (PPI), which has implications for the price of goods exported to the world, fell by 1.4% in February, after falling also in January by 0.8%. The very low inflation that China enjoys helps the local authorities to be able to provide stimulus to the economy, by cutting interest rates when it is appropriate, a luxury which cannot be afford by the ECB or the FED.
The US inflation numbers are expected this week. The February headline number is expected to have eased down to 6% from 6.4% in January, with a monthly increase of 0.40%. The Core CPI is expected to have remained around 5.5%.
In corporate news, Meta Platforms (Facebook) is expected to fire thousands more people, on top of the thousands of layoffs announced late last year, in another sign that revenue growth is not enough to protect the company's profitability goals. Tesla also announced further price cuts for its most expensive models, as demand has apparently fallen. Volkswagen provided guidance for this year which was much higher than expected by the consensus. The company expects revenue growth of 10-15% while most analysts were expecting a small drop and operating margin of about 7%, whereas analysts were expecting close to 5%. Overall, a very positive guidance, although the bears will say it is too optimistic to be achived. Shares moved higher by 10%.
Chart of the Week : The US Regional Banks shares collapsed.
The above chart shows the price performance of the KBW Index, which is the regional banks in the US. The index has risen almost 15% this year before the news on the SVB bank surfaced on Thursday. Then fears and panic of more regional banks going to fail because of their exposure to US Treasury bonds and the subsequent losses on them, led the index fall by 20% in a matter of just a few days. The index is now quickly at a new low for the bear market, which started in January of 2022, as shown in the graph (where the peak is). It is really unknown whether the rumors and fears will eventually materialize. For the moment, as we have said several times in the recent past, it is wiser to remain cautious on equities and have exposure primarily in quality names and defensive sectors which had become unwanted until last Thursday.
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• Sources: Chart of the Week : Factset