Dancing On The Ceiling

Rapid change continues, despite repeated requests from all for a quiet 2023. There are certainly signs that inflation is back under control, or at least not spiralling out of control. Increments are reducing, and ‘pause’ is becoming an important word. Although Australia, one of those earliest hikers, went against market sentiment and gave us another 0.25% which also, pleasingly, did not cause outrage or disruption. On the other hand, signs of potential implosion are being seen beyond US domestic banking names. Serious questions are now also being raised about exposure to real estate, in particular those of a commercial flavour and outside of the largest of bubbles now popping in China.

If that were not enough, we are also seeing stresses off the back of the US government’s inability to agree to raising the debt ceiling, effectively blocking the issuance of further debt and interest yet to be paid. Treasury bill yields have reversed course and US CDS (credit default swaps, or roughly the price to ensure against a default, technical or otherwise) below. 

Bloomberg LLP

Quite the move and an altogether different take on “Top of the Pops”. One might expect aggressive hikes to strengthen the dollar and adversely affect those countries trying to catch-up, who are suffering off the back of yet another inflationary hit, but the market is saying something really quite different, and it is by no means a rounding error…

The final column shows us the biggest losers, in this case the US seeing an almost 1250% rise in insurance costs, followed not so closely by Switzerland at 237% (from the major liquid markets in this product, other jurisdictions are available). Whilst the above captures the last 4 years, we are now at an all-time high. Regardless, credibility is now being called into question. Whilst the ability to repay is not in doubt, creating a potential technical default benefits almost nobody.

Against a backdrop of three bank failures in only a matter of weeks, and moving away from a place of vulnerability, the first quarter was one of record profits for the banking sector. Tha main drivers have been net interest margin, along with higher interest rates that are coupled with low default rates and supported by continued strong employment. Profits in the US banking sector alone were up 33%, or $80Bn. Not bad for three months of work. Turmoil creates opportunity for the strong. Headwinds are coming though. FDIC insurance does not come for free and now requires “replenishment”. How much? $20Bn from SVB alone. 95% of the top up is to be paid by those with more than $50Bn in assets.

Interesting to also note the continued drawing of lines in the sand. Significant progress has been made by the BRICS emerging market’s powerhouses of Brazil, Russia, India, China and South Africa in attracting new members. Prior to this year’s summit, bids were made by no less than 19 countries to join. At the same time, the Italian Prime Minister on a state visit to the US announced that Italy would be pulling out of China’s Belt and Road Initiative. Relationships have soured and decisions appear to be in the balance between economy and security. On an economic front, Italy saw Fitch reaffirm their BBB rating with stable outlook in their latest credit assessment, amongst others noting that Primer Minister Meloni’s recently published ‘Stability Programme’ had set credible fiscal targets. Coupled with a similar S&P decision in April, this no doubt will be interpreted by some as a vote of confidence for the recently published fiscal strategy, however, it remains to be seen where the review of Moody’s comes out this upcoming Friday.

Another month, another ECB meeting, and yet another 0.25% hike. Much like elsewhere, the magnitude of tightening has reduced. There are several factors that continue to be at play. In particular, the TLTRO (targeted longer-term refinancing operations) from the ECB are coming to an end. The days of super-cheap Euros now really are a thing of the past. Ending next month, it is prudent to see how this might affect the flow and price of liquidity to the broader economy. Is this a feast to famine? Ideally not. The Eurozone must continue to contend with diverse member nations. Variance of inflation along with prudence (or lack thereof) around budget will continue to pain committee members. For now at least, the market believes we are close to cycle-top, with just over 0.25% of tightening priced in for the beginning of summer.

We heard from the BoE on Thursday, which the market largely viewed as more confusion than clarity. Whilst the hike was a given and clearly necessary (inflation remains above 10%!), the Bank revised growth figures catching investors somewhat off guard. Back in November, it was all doom and gloom. We were apparently already in a recession that never transpired. Now the outlook has almost switched to a rosy one, with the size of the economy set to increase 0.9% in a year versus the previous -0.3% projection. At least another hike is expected and arguably very much needed, to say the least.

Putting debt ceiling and regional bank woes aside, the Federal Reserve chose not to pause at the last meeting. Employment remains strong and holding up better than expected. The consumer is showing continued signs of resilience and there is potential that price stability and outright level are being tamed. Questions still remain as to what the eventual cost might be.

Courtesy of Flowbank

Let’s hope, as indicated above, that history does repeat itself here at least. Away from this, regulation has once again been bent to avert further failures. The moral hazard of effectively underwriting a huge swathe of deposits is an experiment that now may likely prove challenging to unwind.