The early weeks of March 2023 have marked the beginning of the most profound market changes since 2008. Three banks in the US failed, either voluntarily (Silvergate Capital) or by being put under FDIC receivership (Signature Bank and Silicon Valley Bank). At least one bank in Europe (Credit Suisse) is under severe stress and had asked the Swiss National Bank on 16. March for a liquidity backstop. The newsflow dominating the first two weeks of this month is similar to early 2008 when Bear Stearns was taken over by JPM after it ran out of liquidity. The triggers however are vastly different from 15 years ago.
For a long time, market participants including ourselves were surprised about the resilience of the US economy in light of the fastest and steepest rise in interest rates in 40 years. Within a week now, the odds for a soft landing on the US economy are most likely out of the window. Markets have sharply repriced the future path of interest rates in the US. The current banking crisis may shave as much as 0.5% from expected GDP growth, as lenders are likely to tighten access to credit going forward to preserve liquidity. Goldman Sachs’ economists were the first to lower their US GDP forecast by 0.3% to 1.2% for Q4 2023 this week. The speed and magnitude of the Fed’s rate hikes since early 2022 have claimed their first victims.
At its upcoming March 22nd open market committee the Federal Reserve Board is in a very difficult position. The CPI and unemployment data for February would have reinforced Chairman Powell’s recent comments, that the job is not done yet, and put a 25 or 50bp hike on the cards. But after the rapidly unfolding banking crisis, a measured decision is needed. Continue to stay on the path and risk putting the banking system under more stress, or take a step back and risk that inflation starts to pick up the pace again?
The ECB has set the pace on 16th March by raising interest rates by 50bp. Inflation in the Euro area is still running higher than tolerable, but policymakers paid attention to the current turmoil in the financial sector by stating they will become more data-dependent, similar to the Fed 4 months ago. The central banks’ first job objective is to keep inflation under control. They might as well say, that dealing with the fallout and stress in the system will be done separately.
Our Investment Committee will be meeting in the days after the Fed meeting. We are currently monitoring market developments on a real-time basis, and will react if necessary by changing our outlook on specific asset classes. Two of our changes from January have already started to yield good returns in the current turmoil. Overweight on Gold and Short Dated US Treasuries will remain attractive in turbulent times.
Happy Investing and stay vigilant!
The stress on the regional money centre banks in the US is the first and most obvious sign of the rapid deleveraging and changing market environment after the fastest and steepest rate increase in 40 years. Moody’s has reacted on 14. March and downgraded the US Banking sector outlook to negative given recent bank runs. We think that the current problems at smaller regional banks will benefit in the near term the larger, systemically important banks that are under stronger regulatory oversight, like JP Morgan, Wells Fargo, Citibank and BofA, as depositors and corporates are becoming more mindful of counterparty risk of their lenders.
The energy sector has been a victim of the increased recession risk, with crude oil dipping below $70/brl. Even renewable energy companies and miners for metals crucial for the energy transition (Copper & Lithium) have seen sharp losses after the SVB collapse, since some companies in the sector entertained banking relationships with the failed lender.
We have been taught as kids, not to try and catch a falling knife, but watch out for buying opportunities in that sector.
Despite expected demand destruction from a deeper recession, market pricing in crude is largely ignoring geopolitical risk at the moment in the oil sector. The US have depleted their strategic petroleum reserves at the end of last year to manage upward price pressures, but inventories are starting to build again at lower prices.
Also for Lithium, a lot of pressure emerged in the sector after recent price cuts by car producers (Tesla) and battery producers (CATL). But with China gradually reopening, we see demand picking up again, and the ambitious switch from ICE’s to EVs in Europe by 2030 will see global Lithium demand increasing at a steady pace of 25% CAGR for the next 5 years. And that’s regardless of boom or bust.
Generally said, central banks control only short dated interest rates but not the longer tenors of the yield curve. (Unless to resort to ‘alternative policy instruments’ like yield curve control and QE, by buying or selling long dated bonds from their balance sheet). With the heightened uncertainty from the banking sector tumult, central banks will have to rethink the pace and magnitude of anticipated rate hikes. If the economy crashes, and systemic risk appears, we might even see an emergency cut, like in 2008.
But at the same time, long term rates reflect more closely the long term expectation of inflation. As we enter a period, where the second to next rates move might even be a cut, we expect the yield curve inversion between 2yr and 10yr to correct itself in the near future. Similar things have happened in 2008, where after first stress signals in the subprime market emerged, the rates curve normalized in a very quick fashion.
We like 1-3yr quality paper, government bonds or high grade credit bonds from issuers rated BBB+ or above.
March 25, 2023
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