Daily Comment (March 22, 2023)
by Patrick Fearon-Hernandez, CFA, and Thomas Wash
[Posted: 9:30 AM EDT] | PDF
Our Comment today opens with an update on the U.S. and European banking crises and what they mean for monetary policy going forward (we also note that the Federal Reserve will release its latest interest-rate decision this afternoon at 2:00 PM EDT). We next review a wide range of other international and U.S. developments with the potential to affect the financial markets today, including an encouraging rapprochement between Japan and South Korea and the latest on the China-Russia summit in Moscow.
U.S. Banking Crisis: In a speech to the American Bankers Association yesterday, Treasury Secretary Yellen signaled that she and other federal officials stand ready to intervene in the banking system again if more banks suffer deposit runs that threaten to spark contagion to other banks. That appeared to mark a reversal for Yellen, since she had previously said the federal government would guarantee banks’ uninsured deposits only if the officials again invoked emergency powers to protect them. In any case, the crisis continues to show signs of dissipating, with bank stocks and other equities having strong price gains yesterday. All the same, we remain worried that additional stresses are building in the bank sector, especially among smaller banks which have substantial exposure to the possibility of mass defaults in commercial real estate. The concerns about issues in commercial real estate have recently been rising sharply.
- Yellen’s statement is part of a burgeoning debate on whether the government should fully insure all bank deposits, or at least raise the insured amount above the current cap of $250,000 per depositor, per bank.
- The maximum FDIC-insured amount hasn’t changed since 2008. However, even if that cap were raised substantially, it still might not cover much of a large company’s deposits. Large corporate deposits can run well into the millions of dollars, or even hundreds of millions of dollars, as shown by the collapse of Silicon Valley Bank (SIVB, $106.04). Companies withdrawing their deposits en masse can destabilize a bank just as surely as individuals can.
- That helps explain why much of the current reform talk centers on the possibility of insuring all bank deposits. However, many Republicans in Congress are pushing back strongly against the idea, largely on moral hazard grounds. While we do expect the crisis will eventually lead to new regulatory reforms, it’s still tough to predict exactly what will happen with the insured amount.
U.S. Monetary Policy: The Federal Reserve wraps up its latest policymaking meeting today, with its decision due out at 2:00 PM EDT. Despite the strong economic data for January and February, we suspect the banking crises in the U.S. and Europe will discourage the policymakers from hiking their benchmark fed funds rate by anything more than a modest 25 basis points. Many investors and observers are even expecting them to hold rates steady.
U.S. Stock Market: With the banking crisis encouraging hopes for lower interest rates, many technology stocks and other “long duration” equities have gotten a boost in recent days. Nevertheless, new data shows that the combined weighting of Apple (AAPL, $159.28) and Microsoft (MSFT, $273.78) in the S&P 500 has now reached a record high of 13.3%. Other big technology stocks have recently somewhat recovered from the beating they took from the Fed’s interest-rate hikes over the last year, but the new data underscores how Apple and Microsoft are now in a class by themselves in terms of market dominance.
European Banking Crisis: Debate continues to rage about Swiss regulators’ decision to zero out the additional Tier 1(AT1) capital bonds of Credit Suisse (CS, $0.9681) as part of its rescue over the weekend. Although AT1 bonds are designed to absorb losses in a bank failure, essentially making them junior to the bank’s equities, some of Credit Suisse’s AT1 holders are reportedly considering legal action against the regulators’ move. In any case, the write-down of the bonds is expected to undermine their value throughout Europe, boosting funding costs for banks.
- As noted above, many investors continue to hope the current banking crises will prompt the main central banks to stop, slow, or even reverse their campaigns to hike interest rates in order to fight inflation. However, they were disappointed by the European Central Bank’s decision last week to hike its benchmark short-term interest rate by an aggressive 50 basis points.
- In a sign that the ECB could continue to hike rates aggressively, German central bank Governor Joachim Nagel discounted any fears that the banking crises would have broad effects on the European banking system and called for the monetary policymakers to be “stubborn” in their rate hikes to fight inflation.
- Nagel also showed no sympathy for the holders of Credit Suisse’s AT1 bonds, saying those who profited from their opportunity should be prepared to shoulder the risk they took. However, he did confirm that the ECB would not follow the Swiss decision to bail in AT1s before a bank’s equity was wiped out.
United Kingdom: The February consumer price index was up a full 10.4% year-over-year, an acceleration from the 10.1% rise in the year to January and far above the expected annual increase of 9.9%. Much of the unexpected acceleration reflected a jump in service prices. While investors before the report had been evenly split on whether the Bank of England would keep hiking its benchmark interest rate at its meeting on Thursday, they are now pricing in a likely hike of 25 bps.
Japan-South Korea: President Yoon Suk-yeol of South Korea yesterday said that he would order his government to return Japan to its “white list” of countries with fast-track trade status after a summit with Japanese Prime Minister Kishida last week. Yoon also expressed his confidence that Japan would soon reciprocate the gesture. The countries have black-listed each other since 2019 because of a dispute over Japan’s treatment of Koreans during World War II.
- The diplomatic thaw and improved trade ties between Japan and South Korea reflect their realization that they need to stand together, along with the U.S. and other allies, to resist China’s increasing geopolitical aggressiveness.
- The upside for investors is that increased trade between Japan and South Korea should be good for both countries’ economies, and for their stocks.
Sri Lanka: The International Monetary Fund (IMF) gave final approval for a $3-billion bailout loan for the country this week, after the government instituted a number of fiscal reforms and convinced key bilateral lenders, including China, to sign onto a debt restructuring program. The IMF deal unlocks $4 billion in other emergency lending and will help alleviate Sri Lanka’s lack of foreign currency reserves and deep recession, although it doesn’t necessarily allow the country to tap global financial markets again.
China-Russia: During their summit meeting in Moscow yesterday, Chinese President Xi and Russian President Putin agreed to “significantly increase” trade between their two countries by 2030, and Putin threw his weight behind the greater use of CNY in trade. Putin noted that about two-thirds of China-Russia trade is now in the Chinese currency, although much of that reflects the fact that Russian exports to the West have been severely crimped by sanctions.
- Separately, the Russian government said it will start using new benchmark oil prices to calculate the taxes its oil firms pay on their exports. Although the G7 countries have imposed a price ceiling of $60 per barrel on Russian oil, recent statistics suggest Russian firms are often getting more than that.
- The tax revamp is reportedly geared to increase the Russian government’s oil revenue by about $8 billion annually.