Wall Street recovered on ease of the banking crisis

Wall Street Futures stumbled early Monday European session after the Swiss government virtually forced UBS to buy out (take over) Credit Suisse in a hectic move late Sunday. As a result CD of UBS jumped, while the scrip plunged, dragging banks & financials (including NBFC) on both sides of the Atlantic as well as the Pacific on the concern of contagion. As per WSJ reports, economists found 186 small and dozens of mid-size regional banks may face risks similar to SVB. Also, two major banks in Europe examine scenarios of contagion and look to the ECB and Fed to step in with statements of support.

On the weekend, U.S. Mid-Size Bank Coalition in a letter to regulators pointed out:

·         FDIC to insure all deposits for 2 years and warned if another bank fails, the deposit flight would accelerate

·         If another bank fails, the deposit flight would accelerate

·         Confidence in our banking system as a whole must be swiftly restored

·         Despite the general health and safety of the banking industry, confidence has been undermined in all but the largest banks

Late Sunday, after days of hectic effort and negotiations, eventually, Swiss banking giant UBS agreed to buy its rival Credit Suisse for around CHF 2B (more than $2B). As part of the Credit Suisse deal, SNB offers UBS around $100B liquidity line. UBS will now pay more than CHF 0.50 a share for Credit Suisse, far below the closing price of CHF 1.86 Friday. The Saudi National Bank, which has a substantial investment in Credit Suisse said: “The change in Credit Suisse valuation won't impact our plans”.

As a part of the Credit Suisse deal, AT1 bonds would be completely written off. Switzerland also considered the nationalization option of Credit Suisse if the UBS deal collapses. In any way, UBS initially offered to buy Credit Suisse for up to $1B. UBS also insisted on a material adverse change that voids the deal if Credit Suisse's credit default (CD) spreads jump by 100 basis points or more. Swiss Government grants UBS CHF 9B guarantee on any potential Credit Suisse losses. UBS plans to cut Credit Suisse's investment bank after the deal and aiming cumulative cost reductions of more than $8 billion by 2027, while employment of CS staff will be continued.

The market is now also concerned about AT1 bond loss. In recent AT1 issuance, most banks paid a coupon cost of 8-10% and bond investors will now demand a higher risk premium across the spectrum. The decision to write down Credit Suisse AT1 could lead to contagion for wholesale funding costs across the banking industry. Corporate bond/credit outlook Credit is being downgraded, and short-term government bonds are being preferred by investors.

On Sunday, SNB issued an official statement:

Swiss National Bank provides substantial liquidity assistance to support UBS's takeover of Credit Suisse

“UBS today announced the takeover of Credit Suisse. This takeover was made possible with the support of the Swiss federal government, the Swiss Financial Market Supervisory Authority FINMA, and the Swiss National Bank. With the takeover of Credit Suisse by UBS, a solution has been found to secure financial stability and protect the Swiss economy in this exceptional situation.

Both banks have unrestricted access to the SNB’s existing facilities, through which they can obtain liquidity from the SNB in accordance with the ‘Guidelines on monetary policy instruments’. In addition, and based on the Federal Council’s Emergency Ordinance, Credit Suisse and UBS can obtain a liquidity assistance loan with privileged creditor status in bankruptcy for a total amount of up to CHF 100 billion.

Furthermore, and based on the Federal Council’s Emergency Ordinance, the SNB can grant Credit Suisse a liquidity assistance loan of up to CHF 100 billion backed by a federal default guarantee. The structure of the loan is based on the Public Liquidity Backstop (PLB), the key parameters of which were already decided by the Federal Council in 2022.

The substantial provision of liquidity will ensure that both banks have access to the necessary liquidity. By providing substantial liquidity assistance, the SNB is fulfilling its mandate to contribute to the stability of the financial system, and it continues to work closely with the federal government and FINMA to this end.”

SNB's Chairman Jordan said:

·         The US Banking crisis aggravated the Credit Suisse crisis.

Swiss President Berset said:

·         It's not possible to restore confidence in Credit Suisse (CS)

·         UBS deal was the best solution to end the crisis

Swiss Finance Minister Keller-Sutter said:

·         The hazard to the state and taxpayers and also to global financial stability is lower than in any other scenario

·         Credit Suisse still has many solid businesses

·         The bankruptcy of CS would have had severe consequences

·         The bankruptcy of CS would have had large collateral damage and risk of contagion for UBS and other banks and internationally.

Swiss regulator FINMA said:

·         There was a risk of Credit Suisse becoming illiquid

·         UBS takeover most effective solution

·         The larger bank requires higher capital buffers

Meanwhile, on late Sunday, U.S. Fed announced a daily USD SWAP facility with major global G20 central banks (Fed, ECB, BOE, BOC, BOJ and SNB) to improve USD liquidity in the global money/funding market and avert another ‘Lehman Moment’ (2008 GFC):

·         The Fed and the central banks of the United Kingdom, Canada, Japan, the European Central Bank, and Switzerland announce a coordinated action to improve liquidity provision through the standing US dollar liquidity swap lines

·         The swap lines between these central banks are a collection of available standing facilities that serve as an important liquidity backstop in global funding markets

·         The swap lines help to alleviate pressures on the availability of credit to households and businesses

·         Daily operations (7-day REPO) will begin on Monday and will last at least until the end of April

·         To improve the effectiveness of swap lines in providing US dollar funding, the central banks currently offering US dollar operations have agreed to increase the frequency of 7-day maturity operations from weekly to daily

On late Sunday, Fed issued an official statement:

Coordinated central bank action to enhance the provision of U.S. dollar liquidity

“The Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank, the Federal Reserve, and the Swiss National Bank are today announcing a coordinated action to enhance the provision of liquidity via the standing U.S. dollar liquidity swap line arrangements.

To improve the swap lines' effectiveness in providing U.S. dollar funding, the central banks currently offering U.S. dollar operations have agreed to increase the frequency of 7-day maturity operations from weekly to daily. These daily operations will commence on Monday, March 20, 2023, and will continue at least through the end of April.

The network of swap lines among these central banks is a set of available standing facilities and serves as an important liquidity backstop to ease strains in global funding markets, thereby helping to mitigate the effects of such strains on the supply of credit to households and businesses.”

Further on late Sunday, Fed's Powell & US Treasury Secretary Yellen said in a joint statement:

"We welcome the announcements by the Swiss authorities today to support financial stability. The capital and liquidity positions of the U.S. banking system are strong, and the U.S. financial system is resilient. We have been in close contact with our international counterparts to support their implementation."

On late Sunday, ECB also issued an official statement about the UBS-Credit Suisse merger deal:

“I welcome the swift action and the decisions taken by the Swiss authorities. They are instrumental in restoring orderly market conditions and ensuring financial stability.

The euro area banking sector is resilient, with strong capital and liquidity positions. In any case, our policy toolkit is fully equipped to provide liquidity support to the euro area financial system if needed and to preserve the smooth transmission of monetary policy.”

Further on Monday, France's Finance Min. Le Maire said:

·         France is vigilant on the market reaction to Credit Suisse

·         Regarding monetary policy, the era of 'free money, is finished

ECB's Villeroy (Bank of France President) said:

·         Global bank stocks could stay volatile for several days

·         French Banks are not concerned by Credit Suisse's problems

·         The ECB's still determined to bring down inflation

·         French banks have strong liquidity and capital

·         The regulation of French and European banks is better than that in the United States

·         France should avoid a recession, French banks are solid

ECB's Kazaks said:

·         The ECB isn’t done with rate hikes if the baseline holds up

Italy's Economy Minister said:

·         Rising interest rates could have a detrimental effect on financial stability, thus they must be carefully calibrated

ECB's Visco said:

·         Financial developments outside of the Euro Area can have an impact

·         The ECB must assess the speed and magnitude of hikes at each meeting

·         The Eurozone financial system is not directly exposed but faces a contagion threat

·         We have all of the tools to counter any liquidity crisis

·         The Eurozone needs to quickly implement a deposit protection tool, like the one that the United States has

ECB's Stournaras said:

·         The European banking system has adequate capital

ECB's President Lagarde said:

·         Wage pressures have strengthened on the back of robust labor markets

·         The ECB toolkit is equipped to provide liquidity if required

·         The Euro-Area banking sector is strong

·         We're ready to act as needed on price and financial stability

·         The ECB is carefully watching market developments

·         Our forecasts are made more uncertain by market tensions

·         The future ECB moves are to depend on the data

·         Inflation is expected to remain excessively high for an extended period

·         The key ECB interest rates remain our primary tool for setting the monetary policy stance

·         Wage pressures have increased as a result of strong labor markets and employees seeking to recoup some of their purchasing power

·         There's no tradeoff between price, financial stability

·         Banks are currently receiving sufficient financing from the ECB

·         The policy is already impacting financial conditions

·         We are very confident that capital and liquidity positions in excess

·         Without the tensions, we would have indicated that additional hikes were required

·         Will better understand the labor market in the spring

·         Demand may be affected by financial constraints

·         ECB's determination on inflation is there and strong

·         Based on the current baseline, the ECB has more ground to cover

·         We are confident that Eurozone banks' capital and liquidity positions exceed regulatory requirements

·         Non-bank financial sector vulnerabilities could exacerbate volatility and asset price corrections

ECB's Stournaras said:

·         Rate increases are mostly a thing of the past

·         There are no problems in the European banking system

·         We are close to the end of a tightening cycle

·         European banking system well equipped with capital

·         On interest rates: We will no longer provide forward guidance and instead, meetings will be data-dependent from now on

ECB’s Centeno said:

·         A number of factors point to an increase in inflationary pressures

·         The most recent developments in the European banking sector give us confidence in the decisions we have made

·         The supply side is responsible for a large portion of the current inflation

·         The issue is not so much the level of interest rates as it is the rate at which they are rising

Conclusion:

After ultra-hawkish jawboning for higher rates in the last few months, it seems that ECB may be now blinking and may prefer to hike by +25 bps each in May and June for a terminal repo (MLF) rate of +4.25%. ECB/Europe is now blaming the U.S. for the global banking crisis and Fed/U.S. is also blaming ‘poor’ Europeans for the same. ECB is also distancing itself from Credit Suisse types of banking crisis for years as Switzerland is not a Euro member state.

After Europe’s Credit Suisse, and U.S. SVB/regional banks' fiasco, the market is now expecting a +25 bps rate hike by Fed 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 Gold jumped, while USD slumped. Also, Gold, US bonds and Yen are now prime beneficiaries of haven flow amid the growing global banking crisis.

As the immediate concern of financial stability eases, both Fed and ECB may go for their planned rate hikes in a calibrated manner to ensure both price and financial stability as well as credibility. Fed may go for calibrated +25 bps rate hikes each on 22nd March, 3rd May, and may also 14th June for a terminal rate of 5.25-5.50% and then pause. Both Fed and ECB will ensure financial stability with liquidity tools and price stability with interest tools as unlike during 2008-10, core inflation is still substantially higher than the +2% targets.

In the early Monday European session, Wall Street, as well as European Futures, stumbled on contagion fear of Credit Suisse bank fall out as-well-as UBS as its CD spread surged. Gold also jumped to a multi-month high of around $2010. But by the U.S. session, all reversed on hopes of a Fed/ECB pause after dovish talks by ECB’s Lagarde. Also, the U.S. FDIC extends the bid window for the Silicon Valley Bridge (SVB) until March as there has been substantial interest from multiple parties. Thus the overall tension of the banking crisis eased and risk trade got a boost.