Daily Comment (March 14, 2023)
by Patrick Fearon-Hernandez, CFA, and Thomas Wash
[Posted: 9:30 AM EDT] | PDF
Our Comment today opens with an update on the Silicon Valley Bank crisis and how it appears to be calming down, at least for now. We next review a wide range of other international and U.S. developments with the potential to affect the financial markets today, including further signs of economic decoupling between the West and China and new moves to lower prices in the U.S. healthcare market.
U.S. Banking System: Yesterday, in the first full day of trading after Silicon Valley Bank (SIVB, $106.04) was taken over by regulators, it appeared that the government’s response to the crisis prevented serious contagion to other financial institutions. There have been reports that bigger banks, which are perceived to be safer, are now seeing an influx of new deposits from the customers of smaller, relatively riskier banks, but we’ve seen little indication of widespread, debilitating bank runs. That makes sense given the aggressive structure of the government’s crisis response and the fact that SVB was arguably a unique institution. Because of its focus on venture capital and technology customers, and its decision to invest much of its portfolio in long-maturity bonds, SVB was especially susceptible to problems. We’re optimistic that the financial system has dodged a destabilizing contagion situation, but some banks remain weakened, so it’s probably too early to send the all-clear signal.
- Multiple regional banks with a high proportion of uninsured deposits suffered steep stock and bond sell offs For example, San Francisco-based First Republic Bank (FRC, $31.21) closed 62% down. Many of those smaller banks’ stocks look set to rally today, but their decline yesterday serves as a reminder that some smaller, tech-focused institutions could still have problems like SVB did.
- Overnight, it appeared that a number of foreign banks were also hit with big stock and bond selloffs related to concerns about their holdings of longer-term U.S. Treasury securities. Those concerns could continue to weigh on those banks’ stock and bond values for a while yet.
- Meanwhile, the Federal Deposit Insurance Corporation told Congress yesterday that they plan to take another swing at auctioning off SVB after failing to find a buyer over the weekend. Since the regulators have now deemed the bank to be “systemic,” the FDIC said it could offer deal sweeteners such as loss-sharing agreements.
- A key remaining issue is whether the crisis will convince the Federal Reserve to slow, stop, or even begin reversing its campaign of interest-rate hikes. Traders have certainly shown that they now expect the Fed to at least moderate future rate hikes, but any unexpected reacceleration in inflation could force the policymakers into making the tough call to keep hiking rates aggressively. Such a move would boost volatility in the financial markets.
Eurozone Monetary Policy: Naturally, the SVB crisis has also prompted speculation that the European Central Bank could slow its recent aggressive monetary tightening. ECB policymakers have already signaled they will hike their benchmark short-term interest rate by 50 basis points at their next policy meeting on Thursday, and that is unlikely to change. After that, however, the SVB crisis and the fear of “breaking something” in Europe could lead to slower rate hikes.
European Union Trade Policy: In an interview with the Financial Times, European Commission Trade Chief Dombrovskis revealed that Brussels is exploring ways to police EU companies’ investments in foreign production facilities to circumvent bans on technology exports to China and other rivals. The revelation provides more evidence that the EU is now getting behind Washington’s effort to clamp down on advanced technology transfers to China in order to suppress its military development.
Global Oil Market: In its monthly oil market forecast, the Organization of the Petroleum Exporting Countries said it still expects global demand to grow to 101.90 million barrels per day this year, up 2.3 million bpd from last year. The forecast is essentially unchanged from the previous month. While OPEC now believes Asian demand will be higher than it originally thought, largely due to China’s abandonment of its strict COVID-19 lockdowns, the organization believes the increase will be offset by weaker demand growth in the developed Western economies.
China: Industry sources say the Chinese government has begun to impede projects to lay and maintain subsea internet cables through the South China Sea, as Beijing seeks to exert more control over the infrastructure transmitting the world’s data. According to the reports, long approval delays and stricter Chinese requirements, including permits for work conducted outside its internationally recognized territorial waters, have pushed companies to design routes that now avoid the South China Sea.
- The Chinese measures are at least in part a response to recent U.S. moves to exclude China from international cable consortiums and block direct U.S.-China connections.
- Taken together, the moves are another example of U.S.-China decoupling in the information technology and infrastructure arenas.
United States-United Kingdom-Australia: President Biden, Australian Prime Minister Albanese, and British Prime Minister Sunak signed a deal yesterday to operationalize their countries’ “AUKUS” defense cooperation deal that was announced in 2021. Under the deal, Australia would acquire at least eight nuclear-powered submarines in an arrangement that is intended to preserve the West’s lead over China in undersea military systems and cement the alliance between Australia, the U.S., and Britain.
- Under the deal, the U.S. will gain additional submarine basing rights in Australia, boosting its ability to deal with China’s increasing military aggressiveness in the region.
- Repairing and rotating attack subs through a base near Perth will also give the Australians experience with operating and maintaining advanced vessels.
- The expanded basing rights are consistent with the U.S. strategy of widely disbursing its Indo-Pacific forces to better protect them from a potential Chinese attack.
- Australia will purchase up to five Virginia class attack subs from the U.S. to improve its sub fleet in the 2030s. Virginia class subs are nuclear-powered, making them quieter than Australia’s current subs and therefore more survivable. They can also patrol much farther without refueling. They are not armed with nuclear weapons.
- By the 2040s, Australia will shift to buying a new class of subs that the U.K. will design using advanced U.S. technology. Those subs will be made in Britain and Australia. As part of the deal, Australia will spend billions of dollars to improve its Perth naval base and expand the submarine industrial bases in the U.S., the U.K., and Australia.
United States-Canada: Volkswagen AG (VWAGY, $18.33) said it will build its new electric-vehicle battery plant in Canada to take advantage of the clean-technology subsidies from the U.S. in last year’s Inflation Reduction Act. As we reported in our Comment last week, the company was lured into making its investment in North America by the prospect of billions of dollars in subsidies from the IRA. It has put plans for a European battery plant on hold to see if the EU comes up with similar subsidies.
U.S. Military Power: In a move little noticed by the press, last week President Biden invoked the Defense Production Act to authorize a Defense Department program aimed at accelerating the rebuilding and expansion of the U.S. hypersonics industrial base. The authorization allows the Defense Department to establish incentives for companies to increase production capacity or quality within critical technology areas that the president deems critical to national defense.
- China and Russia remain far ahead of the U.S. in fielding sophisticated hypersonic missiles, which can fly at several times the speed of sound and be maneuvered to dodge anti-missile defenses.
- After several failed tests, the U.S. finally scored some successful tests of its hypersonic technology last year. The new DPA authority suggests the Defense Department is preparing to mass produce the new weapons in order to better compete with China and Russia’s militaries.
U.S. Healthcare Industry: Novo Nordisk (NVO, $140.54) said it will cut the U.S. list prices of several of its insulin drugs by up to 75% beginning in January 2024. In addition, the company will cut prices for its unbranded insulin products to match the reduced price of its corresponding brands. Novo Nordisk’s move follows a similar price cut by Eli Lilly (LLY, $324.49) earlier this month. The price cuts, made under pressure from the Biden administration, will primarily benefit uninsured people, as insured patients often pay fixed co-pays for their insulin.