By Ben Norris, CFA, Securities Research Analyst, Associate Vice President
The domestic banking crisis continued last week and expanded into a global crisis as Credit Suisse Group was forced to accept a $50 billion capital injection from the Swiss National Bank. Credit Suisse has been plagued by issues over the last several years, but the acceleration of deposit outflows last week was the straw that broke the camel’s back. Credit Suisse teetering on the brink was just the tip of the iceberg in an exceedingly busy week in the markets. Investors began the week still reeling from the collapse of Silicon Valley Bank (SVB) and the Fed’s decision to create a support program designed to prevent further bank runs like the one that led to the demise of SVB. The “Bank Term Funding Program allows banks to obtain loans from the Federal Reserve (Fed) by pledging high-quality assets that the Fed is eligible to purchase (U.S. Treasury, U.S. Agency, and U.S. Agency Mortgage-Backed Securities). A key difference is that the Fed will lend against these securities at their par value rather than their current market value.
This contrasts with SVB’s situation a few weeks ago when it was forced to sell a large portion of the assets held on its balance sheet at a nearly $2 billion loss to meet customer withdrawal requests. The Fed’s campaign of rapid interest rate hikes has led to a significant decline in the market value of assets held on many bank balance sheets (bond prices fall when interest rates rise). In normal circumstances, banks would just hold these assets to maturity and receive par for the bonds. However, the demise of SVB has caused investors and customers to take a closer look at bank balance sheets, especially regional banks with concentrated deposit bases. Upon closer inspection, some banks are in a similar position to SVB and would likely be in peril if it were not for the Funding Program and support from the Fed.
It is important to note the difference between the current banking crisis versus the Great Financial Crisis. The GFC was a product of bad underwriting practices and inflated home prices. Home prices fell from bubble levels and many outstanding mortgages were underwater. The current crisis is a product of asset-liability mismanagement in the face of rapidly rates rising interest. In other words, banks now are not facing an insolvency problem, they are facing a liquidity problem. SVB didn’t necessarily make bad loans, but it did invest its customer deposits poorly, a situation uniquely tied to recent monetary policy decisions of the Fed and other central banks. The Fed cut interest rates to 0% in response to the GFC and was forced to cut them once again during the pandemic to stimulate economic activity. Because interest rates were held artificially low for the better part of a decade, investors of all kinds (individuals, banks, retirement plans, asset managers, etc.) were forced to stretch for yield on the lower risk portion of their portfolios. In other words, the duration of many fixed income portfolios moved higher and became more sensitive to changing interest rates. This problem was exacerbated by the fact that the overall level of rates started so low – higher yields help protect against interest rate risk.
When the Fed began to raise rates a year ago in response to record inflation, many investors were caught flat- footed. Very few people anticipated just how high and how quickly the Fed would raise rates. In my opinion, the Fed and other regulators are just as much to blame for the current crisis as the banks are. The Fed’s decision to hold rates so low for so long was bound to create issues eventually. It’s clear now that the Fed went too far in its support of the economy in the last decade, and now they’ve gone too far in efforts to undo the damage. Banks (and other investors) had no choice but to reach for yield in a 0% interest rate environment and the Fed should have foreseen the consequences of hiking rates from 0% to nearly 5% in less than a year. There is a saying on Wall Street, “Whenever the Fed hits the brakes, someone goes through the windshield. You just never know who it’s going to be.”
Last week we wrote about the contagion created by the collapse of SVB. It appears that the contagion has spread across the Atlantic and has hit Credit Suisse. Late last week it appeared that Credit Suisse was facing many of the same deposit outflow issues that domestic banks were facing as customers worried about a run on the bank. The week began with CS reporting that it had found “certain material weaknesses” in its internal controls over the last two years. The bank paired this with news that depositors had withdrawn more than $120 billion in fourth quarter 2022, a significant sum for a bank with $800 billion in total assets as of this time last year. The Saudi National Bank, an investor in Credit Suisse, indicated that it would not invest further capital into the bank due to regulatory limits. This led to the Swiss National Bank to issue a statement that it would intervene if necessary. The following day the Swiss National Bank opted to provide roughly $50 billion in capital to help shore up Credit Suisse’s liquidity and helped calm fears that a full meltdown would commence. Unfortunately, the situation got worse over the weekend as investors lost confidence that the drastic steps taken last week were enough to save the bank from rapidly falling deposits. Swiss regulators spent the weekend brokering a deal where UBS, the largest Swiss bank, would acquire Credit Suisse for pennies on the dollar. As part of the deal, Credit Suisse’s $17 billion in debt was wiped out, leaving bondholders with nothing. The fate of Credit Suisse’s operations is unclear, but the expectation is that much of the bank’s operating units will be wound down or incorporated into UBS on a limited basis. It appears that a full-on crisis was averted thanks to quick action by Swiss regulators, but I think we could see a few more passengers go through the windshield before this crisis is over.
Despite the bank issues last week, stocks somehow finished mixed, rather than seeing broad declines. Higher quality bonds rallied as rates plunged in response to expectations that the Fed could pause its rake hikes. One particularly helpful development last week, was inflation data that was in-line with expectations. February’s reading of Consumer Price Index (CPI) saw a 6.0% increase year-over-year, which is still high, but an improvement from the 6.4% increase in the prior reading. Core CPI, which removes the influence of food and energy prices, saw a 5.5% increase, down from 5.6% in January. Wednesday brought the February reading of the Producer Price Index (PPI), which saw a 4.6% increase versus last year, down from 5.7%. Core PPI was flat versus last month, notching a 4.4% year-over-year increase. I imagine that Fed Chairman Jerome Powell breathed a sigh a relief when the numbers were released. In line readings on inflation have likely given the Fed some cover to either go ahead with a 0.25% hike or pause hikes until they can re-evaluate at May’s policy meeting. Small-cap stocks were the biggest losers last week as investors fled to the safety of large cap stocks. The Russell 2000 lost 2.6% while the S&P 500 gain 1.5%. Mega-cap growth stocks were notable beneficiaries of the flight to safety last week as investors seek to own stocks with strong balance sheets. The NASDAQ Composite gained an impressive 4.4%.
The highlight of the coming week will be the Federal Open Market Committee’s decision on interest rates. As recently as a few weeks ago, markets expected the Fed to raise rates by another 0.5%. The recent turmoil in the global and domestic banking sectors has investors unsure of the Fed’s next steps. Some believe the Fed will go ahead with a smaller 0.25% hike, while others believe it will forgo a hike altogether. No matter what the Fed decides, their path forward continues to get more complicated.
| Date | Report |
Previous |
Consensus |
| Monday 3/20/2023 | |||
| Tuesday 3/21/2023 | Existing Home Sales (February, SAAR) |
4.0M |
4.16M |
| Wednesday 3/22/2023 | Federal Reserve Interest Rate Decision | ||
| Fed Chairman Jerome Powell Press Conference | |||
| Thursday 3/23/2023 | Initial Jobless Claims |
192,000 |
200,000 |
| Continuing Jobless Claims |
1.68M |
||
| New Home Sales (February, SAAR) |
670,000 |
649,000 |
|
| Friday 3/24/2023 | Durable Goods (February) |
-4.5% |
+0.7% |
| U.S. Services PMI (March) | 50.6 |
50.3 |
|
| U.S. Manufacturing PMI (March) |
47.3 |
47.0 |
Links to previously published commentaries can be found at benjaminfedwards.com/Latest Investment Insights/Weekly Market Commentary/Market