Stocks wobble amid bank crisis on both sides of the Atlantic

Stock markets on both sides of the Atlantic plunged further Wednesday on the growing bank crisis in the U.S. as well as Europe. Wall Street/European Futures were already under stress on the regional banking crisis in the U.S. led by SVB but recovered to some extent Tuesday on the Fed bailout. But Wall Street Futures were also undercut Tuesday as a Russian jet downed a U.S. drone on the Black Sea, near Ukraine/Crimea-Russia border.

On early European session Wednesday, Wall Street/Dax and other European/global futures tumbled after Swiss Banking giant (?) Credit Suisse (CS) plunged as Saudi National Bank Chair ruled out more assistance/further investments into the fragile bank. CS was already trading at all-time lows after it said Tuesday that its financial reports had a material weakness. And CS further plunged, while its CDs jumped to record highs after the bank's top shareholder, Saudi National Bank Chairman Ammar Al Khudairy, whose stake has lost more than one-third of its value in three months, ruled out investing any more in the troubled Swiss bank as a bigger holding would bring additional regulatory hurdles.

Saudi National Bank, which owns a $1.5B stake in CS following the group's capital-raising effort last year, said it was pleased with the bank's recent turnaround plans, which include the separation of its investment banking unit and noted that its equity capital ratios were consistent with Swiss regulations, but said it can't go over its current 9.9% threshold due to a 'regulatory issue'. As a recapitulation, CS has been suffering from a host of scandals and missteps over the past years that have triggered an exodus of client deposits from both its bank and wealth management divisions and said earlier this week that it found ‘material weaknesses’ in its financial reporting and internal controls.

On Wednesday, in a BBG interview, Khudairy was asked whether his bank was open to further injections if there was another call for additional liquidity: “The answer is not, for many reasons outside the simplest reason, which is regulatory and statutory”. Subsequently, not only did CS stock plunge, but it caused panic in banking as-well-as other stocks on both sides of the Atlantic as-well-as Pacific. But Gold, USD, and US bonds also jumped on haven appeal, while EUR and GBP plunged.

The market is now also concerned about the side effect of higher interest rate/bond yields and subsequent plunge in bond prices resulting in huge unrealized (MTM) loss in the HTM bond portfolio of not only small/mid-size banks but also big ones.

Charles Schwab which has higher unrealized losses in its HTM bond portfolio of around $14.1 billion, also has ample liquidity access, including $100B cash on hand, as well as a deposit base that is 82% covered by FDIC insurance. But the CEO Bettinger has to purchase almost 50K shares of his brokerage/investment bank firm in a do-or-die effort to install confidence among investors.

Charles Schwab CEO Bettinger, who has led Schwab since the 2008 GFC, said while there is some mismatch between client assets in its banking division and held-to-maturity (HTM) assets on its balance sheets: "Our clients are not reacting in the manner that the doomsday scenario would indicate. Our available-for-sale portfolio is short in duration and high in quality, and our held-to-maturity is slightly longer in duration but still short compared to many people, and very high-quality”.

On Wednesday, after the CS fiasco and subsequent ‘dooms day’ scenario across global markets, reminding the 2008 GFC (Lehman moment), the U.S. and also some other G7 countries/central banks reportedly reached (pressurized) Swiss authority/SNB to bail out CS (as U.S./Fed bailed out SVB/other small banks) and stabilize the financial market. There was also a report of thin liquidity in the U.S. treasury market!

Subsequently, the Swiss government/SNB blinks and assured to bail out CS. A Swiss MP Matter said: “To assist Credit Suisse, the Swiss Central Bank would provide liquidity in exchange for collateral.”

The SNB and the Swiss regulator FINMA said Credit Suisse (CS) meets the capital and liquidity requirements imposed on systemically important banks (too big to fall) and that the SNB will provide the bank with liquidity if necessary. Subsequently, Wall Street Futures recovered and GOLD, USD, and US bond yields stumbled.

The SNB said:

“The Swiss National Bank SNB and the Swiss Financial Market Supervisory Authority FINMA assert that the problems of certain banks in the USA do not pose a direct risk of contagion for the Swiss financial markets. The strict capital and liquidity requirements applicable to Swiss financial institutions ensure their stability. Credit Suisse meets the capital and liquidity requirements imposed on systemically important banks. If necessary, the SNB will provide CS with liquidity.

The SNB and FINMA are pointing out in this joint statement that there are no indications of a direct risk of contagion for Swiss institutions due to the current turmoil in the US banking market.

Regulation in Switzerland requires all banks to maintain capital and liquidity buffers that meet or exceed the minimum requirements of the Basel standards. Furthermore, systemically important banks have to meet higher capital and liquidity requirements. This allows the negative effects of major crises and shocks to be absorbed.

Credit Suisse’s stock exchange value and the value of its debt securities have been particularly affected by market reactions in recent days. FINMA is in very close contact with the bank and has access to all information relevant to supervisory law. Against this background, FINMA confirms that Credit Suisse meets the higher capital and liquidity requirements applicable to systemically important banks. In addition, the SNB will provide liquidity to the globally active bank if necessary. FINMA and the SNB are following developments very closely and are in close contact with the Federal Department of Finance to ensure financial stability.”

Earlier Credit Suisse appealed to the SNB for a public show of support. In any way, the market was also supported by a source-based news headline:

·         US banks watching for potential Credit Suisse contagion

·         In recent months, large US banks managed exposure to Credit Suisse

·         Exposure to large US banks by Credit Suisse is seen as manageable

On Wednesday apart from the growing banking contagion/crisis saga, some focus of the market was also on U.S. PPI and retail sales data as Fed may also consider these along with employment and inflation data already published for its 22nd March rate action decision and SEP thereof.

On Wednesday, the BLS flash data shows the annual (y/y) U.S. PPI (Producer Price Index) further eased to +4.6% in Feb’23 from +5.8% in Jan’23, lower than the market consensus of +5.4% and lowest since Mar’21 (seasonally adjusted).

On a sequential (m/m) basis, the U.S. PPI contracted -0.1% in Feb’23 from +0.3% in Jan’23 and below market expectations of a +0.3% rise (seasonally adjusted). Goods prices decreased by 0.2%, after a 1.2% rise in January, namely food (-2.2%) of which chicken eggs (-36.1%); and energy (-0.2%). The indexes for residential natural gas, fresh and dry vegetables, diesel fuel, home heating oil, and primary basic organic chemicals also fell. In addition, services cost went down 0.1%, the same as in the prior month. Margins for final demand trade services fell by 0.8% and prices for final demand transportation and warehousing services decreased by 1.1%.

The annual (y/y) U.S. core PPI also eased further to +4.4% in Feb’23 from +5.0% in Jan’23. The sequential (m/m), core PPI was almost unchanged in Feb’23 from +0.1% in Jan’23.

On early Wednesday, Wall Street Futures also got some boost on colder than expected PPI, which may refrain Fed from any big rate hike (+0.50%).

Conclusion:

After SVB/regional banks' fiasco, the market is now expecting a +25 bps rate hike on 22nd March and a pause. Further, some market participants are now also expecting Fed may prefer financial stability over price stability and may not even go for any hike on 22nd March. A few market participants are also expecting rate cuts to the tune of -75 bps by Dec’23 for the sake of financial (Wall Street) stability. Thus Wall Street Futures and Gold jumped, while USD slumped. Apart from regional banks, Fed is itself now bankrupt, at least theoretically with a negative net worth currently around -$1.1T. As a debt manager of the U.S. government, Fed along with Treasury has to ensure lower borrowing costs, whatever may be the narrative, and thus US10Y bond yield of around 4.25-4.50% is a red line for Fed.

U.S. is now paying almost 10% of tax revenue as interest on public debt and CBO projected around 13% and 15% for 2023-24 even after assuming an average 10Y US bond yield of around 3.80-3.90%. This is a red flag for U.S. fiscal math. China and the EU’s debt interest/tax revenue is currently around 5.5%, while Japan’s is 15%.

As a debt manager of the government, every central bank including Fed has to ensure lower borrowing costs for deficit spending, whatever may be the narrative. Thus Fed will take a balanced approach to control inflation, employment, and bond yields. Fed may not allow a US10Y bond yield above 4.25-4.50% under any circumstances (recent high around +4.08%) whatever may be the narrative.

Fed also has to ensure a softish landing, if not soft (mild employment/economic recession and 2% price stability); i.e. financial and price stability at any cost, If Fed does not hike on 22nd March for SVB/small banks crisis, it may affect its credibility and show Fed is panicking.

Bottom line:

Fed may go for calibrated +25 bps rate hikes each on 22nd March, 3rd May, and 14th June for a terminal rate of +5.50% and then pause. Fed has to ensure price stability, financial stability and also own credibility.