March proved to be very eventful and volatile, and the next few months can only be the same. As we have already mentioned, central banks and governments have demonstrated clearly at this stage that they will not allow any bank to hurt its depositors, even those above the insured amount. They have the power and the will to avoid the 2008 mistakes. But at the same time, we cannot see how the economies in Europe and the US will not be hurt by the slowdown in credit flow from the banks and the very high interest rates, which only now start to show their real effect on various parts of the economy. And lower economic activity impacts the profitability of companies. As the recent rally has brought indices back to levels which are close to the period before the recent banking crisis, one must be very skeptical if much more upside is justified before we fully understand the real effects of the recent events. High quality bonds seem to offer a better risk-reward than equities at these levels.
Commercial real estate is the next big concern. The sector has had several blows in recent years. First was the pandemic which popularized the notion of «work-from-home», while shopping malls were already in a secular declining mode. Then the meteoric rise in interest rates has led to a similar rise in borrowing costs, making some leveraged players rather vulnerable And now we are in a middle of a banking crisis, which has hit primarily the smaller banks. Small banks account for almost 70% of the loans to the commercial real estate sector. Tighter lending standards will choke some companies in the sector and defaults should be the natural outcome, with unknown repercussions to creditor banks and the local economies of course. The exposure of small banks to the sector is more than 40% of their loan books, which also leaves the banks vulnerable to big losses.
Saudi Arabia announced yesterday an unexpected cut of oil production of 500k barrels per day. The move was outside an OPEC+ meeting, with all other countries following with their own announcements and the overall cut in supply will be in excess of 1mn barrels per day. Oil prices surged by 8% in early Asia trading and WTI is again close to 80$. This is a concerning event, which shows that the Saudis are sending messages to the US that they are not any more on their side exclusively. The recent agreements with China point to this fact also. It also shows that the OPEC+ is really worried for demand going forward, or in other words they expect a recession too.
Equities had a very positive week, as bank failure fears have been set aside for now. Most indices in Europe and the US rose by 3-4%, Chinese local equities had a lackluster week with about 1% increase. In terms of sectors, the rally was rather broad, but a special note should be made for Energy stocks which recovered by 6%, after several weeks of negative performance. Swiss stocks also rose in line with their peers this time, changing the recent momentum of under-performance every time equity markets were recovering.
Bonds lost some ground as sentiment has improved. Prices fell and yields rose, but the moves were rather small and on Friday bonds attracted again buying interest. The US 10-year closed at 3.49% up from the lows of 3.35% at the start of the week, while the German equivalent finished at 2.30% up from 2.10%.
The Eurozone March headline inflation dropped, but core remains an issue. The CPI was announced at 6.9% vs expectations of 7.1% and compared to the 8.5% of the previous month. The big drop of commodities as well as the stabilization of consumer goods' prices has helped inflation come down from the peak of 11% just a few months ago. But the cost of services (rents, leisure, travel etc) continues to move higher, albeit at a lower rate than last year. Hence the core CPI posted a new high for the cycle, at 5.7% (5.6% in the previous month) and is expected to keep the ECB nervous.
The February US PCE deflator fell further. The Personal Consumption Expenditure deflator is the FED's most favorite metric for inflation and was announced at 5.0% vs 5.3% in January. The Core fell to 4.6% vs 4.7% in the previous month. All in all, the week's inflation data in Europe and the US confirmed that we have seen the worst of inflation for now and prices continue to stabilize , however at higher levels than two years ago.
The March Chicago PMI remained at depressed levels. It was annouced at 43.8, slightly better than the 43.6 level of the previous month , but still deep below the 50 mark, which signals expasion. This was another confirmation that manufacturing in the US is undergoing a major slowdown.
In corporate earnings, UBS brought back its previous CEO, Mr. Ermotti, to help the bank successfully integrate Credit Suisse. The fired CEO was already facing criticism and stayed at the top job only for about 3 years. Novartis presented positive results on a phase III test concerning a combination of drugs for breast cancer. Its shares rose by 10% for the week.
Chart of the Week : Euro area banks had also tightened lending standards before the recent crisis.
Last week we presented a similar chart for US banks. The above chart this time shows the net percentage of Euro area banks which answered that they have tighthened their lending standards, which means either much higher interest rates for corporations and/or less loans approved. It is impressive that the data are from last year and the last column which demostrates a big jump is the 4th quarter. The percentage of banks which have tightened their lending standards is now higher than during the pandemic in Q4 2020. This is even before the current banking crisis, which is expected to further have further worsened the situation. Looking at this data together with the other data from the ECB which show a collapse in new loan demand, it is very hard to see how the economies will avoid a recession in the coming months.
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• Sources: Chart of the Week : ECB, Euro area bank lending survey