Spring 2023 Market Newsletter
Christopher Bowlby - Apr 18, 2023
The month of March has seen a lot happen with the collapse of multiple banks on both side of the Atlantic and bailout measures which were not able to calm the upheaval. Additionally, we saw rate hikes by both the ECB and the Federal Reserve of 50 bps
“There are decades where nothing happens; and there are weeks where decades happen”—Lenin.
The month of March has seen a lot happen with the collapse of multiple banks on both side of the Atlantic and bailout measures which were not able to calm the upheaval. Additionally, we saw rate hikes by both the ECB and the Federal Reserve of 50 bps and 25 bps respectively, and investor confidence in both riskier assets such as equities and safe assets in bank deposits rapidly decline. The fear of contagion swept across markets in March and required the creation of massive liquidity programs by the Federal Reserve and Suisse National Bank to try and calm financial participants. Ultimately, we saw the collapse of SVB and the forced takeover of Credit Suisse by UBS with a few other financial institutions, particularly in the regional banking sector in the US still be under immense pressure such as First Republic Bank.
Continued Fallout of SVB, First Republic and Credit Suisse
Since our last market newsletter, Silicon Valley Bank and the Regional Bank Crisis, we saw continued pressure on smaller and troubled financial institutions. In the US, First Republic Bank, a regional bank in California, was the next victim in the crisis of confidence and continues to fight for survival as the flight of deposits left it in critical condition after its credit rating was cut to Junk status by S&P. In an unprecedented move, since the collapse of Long Term Capital Management, a string of banks have made uninsured deposits totalling $30 billion into First Republic Bank to shore up the deposit base which had seen $70B in withdrawals since the beginning of the crisis. This included deposits from Bank of America, Citigroup, JPMorgan Chase, Wells Fargo, Goldman Sachs, Morgan Stanley, BNY-Mellon, PNC Bank, State Street, Truist and U.S. Bank. This move was reminiscent of J.P. Morgan in the Panic of 1907 where he single-handedly stopped a string of bank runs with the prop up of the Trust Company of America. Additionally, the Financial Stability Oversight Council is looking to expand the BTFP in order to give more time to First Republic Bank more time to shore up its balance sheet.
Given that the crisis of US regional banks is one of a crisis of confidence, the only solution is to stem the flight of withdrawals from smaller regional banks to larger institutions. From JP Morgan’s research, around $1.1 trillion has exited the most vulnerable US banks, half of which exited during the week ending March 15th. While some of these deposits have shifted the larger institutions, one of the biggest flows was to Money Market Funds. The biggest driver of fund flows has been from the increase of interest rates by the Federal Reserve which has put pressure on fixed income assets and provided a higher yielding alternative to savings deposits. Additionally, with FDIC only covering up to $250,000, there was roughly $7tr of uninsured bank deposits prior to the crisis at SVB and with the loss of confidence, depositors were able to move assets to higher yielding and arguably safer products.
The crisis of confidence that started with SVB crossed the Atlantic to Credit Suisse. Over the past few years, Credit Suisse has faced multiple crises, including the collapses of Greensill Capital and Archegos Capital, which forced the bank to take a $5bn hit which was equivalent to one year of profits for the bank. Over 2022, Credit Suisse had already seen a 40% drop in deposits and a 30% drop of assets.
After the collapse of SVB, the flight to quality caused investors and deposits to question all of their banking relationships and as such pulled assets from Credit Suisse. Back in November of 2022, the Saudi National Bank invested $1.46bn in Credit Suisse and taking a 9.9% stake in the bank. Adding fuel to the crisis, the Chairman of Saudi National Bank stated that due to regulatory issues, SNB would not be invested any more into Credit Suisse and acted as a catalyst for further sell off, intensifying the crisis of confidence. Ultimately, the Swiss government was forced to step in and issue a $50bn lifeline to Credit Suisse while trying to find strategic options. Finally, with cajoling from the Swiss government, UBS was pushed into a deal to curb further panic about the stability of the banking industry. UBS agreed to pay Credit Suisse shareholders $3bn francs and the Swiss government agreed to backstop $9bn francs of potential losses from Credit Suisse’s assets and allowed UBS to wipe out about $17bn of Credit Suisse’s bonds.
There are many continued knock on effects from the banking crisis and we expect there to be the potential for a credit crunch as lenders pull back and take a more conservative outlook and tighten lending standards. If this comes to fruition, we expect that we will see continued tightening of the economy but conversely a reduction of inflationary pressures.
In the end of March, the Federal Reserve increased interest rates by 25 bps to 4.75%-5% and left the terminal rate on their Summary of Economic Projections dot plot unchanged. However, the commentary from the Federal Reserve shifted slightly to a more dovish guidance on future policy hikes and an admission that their hawkish monetary policy could impact banks.
A lot had changed between the previous Federal Reserve meeting on February 1st and the March meeting. In early March, Chairman Powell had an extremely hawkish hearings with Congress and then dovish interventions of the global financial system which has caused rate expectations to shift dramatically swinging between 75% odds of a 50 bps move in March to an 80% chance of a 25 bps increase.
In the high wire walk that was the press conference following the FOMC meeting, Chair Powell delicately threaded the needle down the goldilocks path. It is clear that the Federal Reserve believe that they have the tools to combat inflation via rate hikes and able to provide additional liquidity to banks via the BTFP. As such, we believe that the Fed is inclined to do one more 25 bps rate increase at their next meeting in May, just in time to start seeing CPI move down meaningfully and the year over year data to begin rolling off.
Bank of Canada
At the beginning of March, prior to the banking crisis, the Bank of Canada hosted their monetary policy meeting and held interest rates steady at 4.5%. The Bank of Canada still maintained its bias that it will tighten further if needed and are continuing to assess economic developments. The Bank of Canada looks to keep its options open depending on inflation and the job market. This continues the path set by the Bank of Canada following their January meeting and looks to remain data dependent for the time being as inflation begins to return to its 2% target.
2023 Canada Federal Budget
At the end of the month, the Federal Government released their 2023 Federal Budget. Despite uncertainty on numerous fronts, the government still looks to roll out net new stimulus of $4.8bn in 2023 and $43bn over six years. This spending mostly comes through targeted spending and tax credits aimed at the clean energy sector. Additionally, the budget deficit currently sits at $43bn with no plan to balance in the coming years.
The budget announced household transfers of $2.5bn “grocery rebate” in the form of a one-time payment for middle- and low-income Canadians on top of the $10bn of “inflation relief” on the provincial level last year. Additionally, the budget announced new measures aimed at the clean energy sector in a response to the U.S. Inflation Reduction Act. The budget also announced the Canadian Dental Plan which has been expanded to provide dental coverage for all Canadian’s with family income under $90,000 without insurance and a $2bn top up to the Canada Health Transfers for the provinces. Finally, there are some more tax increases aimed at higher-income Canadians and businesses worth roughly $4 billion annually a few years down the road.
To learn more about the 2023 Federal Budget, we have included a document prepared by BMO Economics to the e-mail.
Q1 Earnings and Looking Forward
Starting in the next few weeks, we will be entering the Q1 earnings season. The financial markets have begun to price in a continued economic slowdown as a result of the banking crisis and the impact of higher interest rates. The last month of March has been a whirlwind with many events that haven’t been seen in over a decade. The knock on effects of the fastest pace of interest rate increase in the last 40 years is still being felt by the economy and markets and now the second derivate effects are being played out. The markets are still forecasting for inflation to slow over the coming months and for the Bank of Canada and Federal Reserve to begin the process of normalization at the end of 2023 and into 2024 which ultimately be a positive tailwind for financial assets. Overall, we continue to believe that despite the turmoil, it remains paramount to remain invested throughout the volatility and to look for opportunities when applicable. Our team did some rebalancing and deployment of capital for clients through the month, especially in areas of the market which were unaffected by the regional bank crisis but we brought lower due to overall market sentiment.