Saturday Hark Back - 25 Mar 2023

Capturing the themes of the week when there’s time to digest them.

Powell takes the middle ground and steps back? Canaries in the coal mine or just badly managed outliers?

So Chair Powell and co took the “wishy washy” middle ground and hiked 25bps and will assess the market over the coming months with regard to further hikes. In so doing he created a clear divide between the Fed’s monetary policy action in the fight against inflation and the wider stability of the financial system. 

A pause was discussed on the back of the turmoil in the banking sector but as things calmed over the week and, with the belief that the banking sector is in a much stronger condition than it was before the GFC, they felt enabled to press ahead with a further hike. As a consequence of the banking crisis, tighter financial conditions are inevitable and as such the Fed feel able to let those conditions do a large part of their future heavy lifting. However, once again we see a disconnect between the Fed and the markets. The “higher for longer” mantra remains in play for the Fed whilst the markets are anticipating rate cuts this year. Once again, do we fight the Fed? It has been a losing battle on the way up as the Fed have stuck to their guns but will it prove to be the same on the way back down? Remember if we look at past Fed cycles they take the stairs up when hiking but the elevator down when cutting rates. This hiking cycle has been shorter and sharper compared to previous ones. It would surely follow that the return ticket down will be equally as short and potentially a lot sharper.

That takes us back to the question: are SVB, Signature, Silvergate and CS just an “opera of canaries” in the coal mine or is there something more afoot? Powell in his press conference when asked about the crisis came out with a rather unconvincing and certainly far from reassuring; “the question we are all asking ourselves over that first weekend was how did this happen?”. Despite this statement, he did claim that the banking sector is sound and that SVB was an outlier. If he is so sure then surely he would know “how this happened”? 

If we look at the individual cases they do seem to have their own unique characteristics. 

CS was a long goodbye who tilted from pillar to post from one crisis to another. Good luck UBS swallowing that bitter pill!

SVB took some “safe” risky bets on its rates portfolio and that old rascal duration came back to bite them, added to the fact that 90% of client deposits were uninsured.

Silvergate never really recovered from the troubled year of crypto in 2022 with the Terra/Luna blow up and the collapse of FTX and Genesis leading to a drop in revenues and huge client withdrawals.

Signature meanwhile had a bit of everything; mirroring Silvergate with its connections to the crypto world and also SVB as it was also a large lender to the tech industry and it too had 90% uninsured deposits.

Standing back then it’s easy to see the view that these were all badly run businesses that had their own unique flaws that eventually did for them. 

Is that not what was said at the time back in 2007/08 when Countrywide Financial, Bear Stearns, Alliance & Leicester and Northern Rock disappeared from view for one reason or another. Then a mere nine months later the banking world almost collapsed into the abyss with RBS and Lehman being the biggest casualties prior to various private and public rescue missions. What followed was a hastily and expensively arranged patch up job for the industry which was supported further by the two pillars of QE and ultra low rates. 

As things start to calm down, the knock-on effects will start to play out in the longer term which will have the effect of eating away at the banks’ liquidity and capital ratios. The super hiking cycle, as the Fed has admitted previously, has not fully fed through into the real economy so more pain is expected. PMIs are struggling to recapture the 50 break even line and the yield curve remains inverted and looks unlikely to reverse that trend anytime soon; a recession seems the most likely outcome and in turn the banks’ loan books will have the inevitable failures draining bank’s capital. Whilst the attention rightly has focused on the banks other financial sectors remain vulnerable. It was not that long ago that the UK pension industry was in a perilous state after the gilt market’s reaction to the Truss and Kwasi budget show. Equally, hedge funds have been seen to take 20/30% drawdowns of late after the recent rates moves. Blackrock also had well-publicised issues with its real estate fund and if they are having issues one would imagine others in the asset management sector are not far behind. 

The banking sector may well be in a stronger state than it was back prior to the GFC but that can’t be said for the state of the central banks’ balance sheets which are bloated beyond all recognition to say the least. Equally they have the little matter of inflation to deal with so cutting rates will stick in their throat when push comes to shove. So this time around the spigots will be a lot harder to turn on full pelt.

The central bankers and indeed the CEOs are all talking a good game and trying hard to calm the markets with warm words of reassurance that all is well, but perhaps it would not take much to scratch away the thin veneer and that “opera of canaries” perhaps will get some new members. 

Some further reading below from Harkster to fill the inevitable gaps.

Mishtalk - Powell wonders how?

Not a yes man's economics - Where next for rates

Macrovoices - Banking crisis and the FOMC

Fortune - Fed backstop billions

ZeroHedge - Fed balance sheet surges

 

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