Daily Comment (March 15, 2023)

by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Our Comment today opens with the latest on the Silicon Valley Bank crisis.  Although the U.S. banking system appeared to be stabilizing yesterday, the jitters touched off by SVB have now sparked concerns about major European banks.  We next review a wide range of other international and U.S. developments with the potential to affect the financial markets today, including several reports touching on economic and political instability in key emerging markets.

U.S. Banking System:  Yesterday brought additional evidence that the crisis touched off by the failure of Silicon Valley Bank (SIVB, $106.04) could be easing, at least domestically.  We have seen no reports of widespread bank runs in the U.S., and the regional banks with relatively high proportions of uninsured deposits saw their stock and bond prices partially recover yesterday from Monday’s selloffs.  However, Swiss banking giant Credit Suisse (CS, $2.51) is suffering enormous declines in the value of its stock and bonds today as the jitters touched off by SVB appear to be spreading to Europe (see next section).

  • As the U.S. financial system stabilizes, attention is turning to the longer-term fallout of the crisis. Importantly, many investors still expect the Federal Reserve to slow, stop, or even reverse part of its ongoing interest-rate hikes when it holds its next policy meeting next week.  We agree that the policymakers might slow their pace of rate hikes, but only temporarily.  After all, even though they’re probably close to the end of their tightening cycle, the policymakers haven’t yet gotten inflation back under control.
    • For investors who assume the Fed will cut rates because of the SVB crisis, we would remind them that the central bank now has a separate tool to address that issue: its new “Bank Term Funding Program (BTFP).” This program allows banks to borrow unlimited amounts from the Fed at the par value of any Treasury, Agency, or mortgage-backed securities they have available to pledge as collateral.
    • Since the BTFP backstop appears to be working to stop widespread bank runs here in the U.S., at least so far, the Fed is likely to feel it can keep hiking interest rates to bring inflation down.
  • Over the longer term, the crisis is likely to spur increased regulation of the banking system. In particular, federal banking regulators are expected to apply their most stringent capital and reporting rules to relatively smaller banks, including those with assets ranging from $100 billion to $250 billion.  Those banks were spared the additional rules in a deregulation measure in 2018, but now they are likely to be re-regulated.  Fed officials have also indicated that they will investigate the downfall of SVB for any criminal behavior.

European Banking System:  As mentioned above, shares of Credit Suisse (CS, $2.51) have dropped some 20% so far this morning.  The bank’s problems are not a direct result of the SVB crisis in the U.S., as the institution has been struggling for years with enormous losses, scandals, management turnover, accounting issues, and other problems unique to itself.  Today’s sell-off was triggered by news that its largest shareholder, Saudi National Bank (1180, SAR, 42.75), has refused to provide any more capital to the bank.  All the same, the concern is that global depositors and investors have now become more suspicious about banks in general, raising the risk of bank runs despite the apparent stabilization we saw in the U.S. yesterday.

  • The stock sell-off in Europe has not been limited to Credit Suisse. Many other major European bank stocks are also selling off sharply so far this morning.
  • As in the U.S., the volatility is generating calls for the region’s central banks to slow, stop, or even reverse their recent campaigns to hike interest rates to fight inflation. The European Central Bank holds its next policy meeting tomorrow, and that potentially sets investors up for disappointment if the ECB decides to stick with its plan for continued aggressive rate hikes.

China:  Retail sales in January and February combined were up 3.5% from the same period one year earlier, reversing the 1.8% annual decline in sales registered in December.  Separately, January-February industrial production was up 2.4% on the year, accelerating from a rise of 1.3% in the year to December.  The figures suggest the economy continues to recover modestly following the end of President Xi’s draconian COVID-19 lockdowns late last year.  That’s a welcome sign for global demand as the U.S. still seems likely to slip into recession later this year and global banking systems are suffering a loss of confidence.

China-Honduras-Taiwan:  Honduran President Xiomara Castro today announced that her country will switch to recognizing China instead of Taiwan, granting a political victory for Beijing’s effort to isolate the island and eventually bring it under its control.  Beijing has recently been luring away more of Taiwan’s allies with promises of trade and investment opportunities, leaving just 13 mostly small island countries that still recognize Taiwan.

Pakistan:  Protests have broken out across the country in response to an attempt by police yesterday to arrest opposition leader Imran Khan on charges of corruption stemming from when he served as prime minister.  The attempted arrest occurred after several months of Khan being locked in a bitter political stand-off with the government of current Prime Minister Sharif.  The political instability comes as Pakistan is dealing with a deep financial crisis brought on by domestic mismanagement, high inflation, and soaring commodity prices.

Argentina:  The consumer price index in February was up 102.5% year-over-year, marking the country’s highest inflation rate since 1991.  Argentina’s soaring prices have largely been attributed to central bank money-printing, as well as the Russian invasion of Ukraine. The amount of money in public circulation has quadrupled during President Fernández’s first three years in office.

Bolivia:  As the country’s foreign-currency reserves shrink and the central bank has stopped publishing reserve figures, Fitch yesterday downgraded Bolivia’s debt deeper into junk territory, assigning it a B- rating with a negative outlook.  As citizens begin to panic about the boliviano’s (BOB) peg to the U.S. dollar, they have been mobbing the offices of the central bank in a desperate effort to buy greenbacks.

United States-Russia:  Yesterday, a Russian fighter jet collided with a U.S. drone flying over the Black Sea, forcing the drone to crash land into international waters.  According to the Pentagon, two Russian Su-27 fighters followed and harassed the spy drone for about 30 minutes, after which one of the fighters dropped fuel on it before speeding away.  The other fighter then tried to do the same, but it came into contact with the drone’s propeller.  Both Russian fighters then landed in Russian-held Crimea.

U.S. Regulatory Policy:  The Environmental Protection Agency proposed a new rule this week that would limit the amount of so-called “forever chemicals” in public drinking water supplies.  The EPA is proposing maximum allowable levels for two compounds in a class of chemicals known as perfluoroalkyl and polyfluoroalkyl substances, or PFAS, which take a very long time to break down.  If finally adopted, the rule is expected to impose costs of billions of dollars on water utilities around the country.

View PDF