The challenge of commenting on markets is that they can move so quickly. Pen hits paper and the information has already expired, much like any current market price on, well, anything! The last couple of weeks have without doubt made this abundantly clear for those in and around our space. Whilst all of this is painful, it is a fantastic learning opportunity, arming the next generation of financial professionals with core knowledge and street-smarts to better navigate the constant unknowns of our world. In depth analysis on the specifics of these events will be covered when it makes sense to do so, ideally in calmer waters. Most useful now, is thinking about where risk may remain and how one might deal with it best.
Once again, contagion and correlation have reared their ugly and frankly gargantuan heads. We’ve seen the lessons of old inflicted on many and watched it reach far and wide from early-stage companies with seed capital in the Valley to the largest institutional asset managers in the now not so sleepy Swiss Alps. Most concerning – the speed at which this has come about and for pretty much all, completely out of the blue. “Be Prepared” goes the motto of the Scouts and it’s forever true. It is not pessimistic to protect oneself from the unexpected, to put measures in place should the world fall apart, rather just prudent to think like a trader wherever one may have risk. What does this mean? Always thinking about where the exit is and how quickly and easily one can get there. Importantly, while remaining unscathed.
Cash is the lifeblood of any organisation and should ideally be in abundance to weather any storm. With funding markets stressed even for the best, a reminder not to rely on only what appear to be cheap and easy solutions that become an Achilles heel. Pay caution to promises of overnight liquidity where the maturity mismatch lurks, striking when least needed, halting redemptions much like a bank facing delays to reopen following an “event”. This does though naturally and rightly lead to more questions than answers. The trouble, as we have all seen, is where to place said funds. If they can disappear in an instant (bar a rounding error of a guarantee), then what exactly should one do? Cash is both a blessing and burden. A hot potato, essential to avoid dropping, painful to manage. Diversification is naturally key, as is having access to the closest proxy to risk-free such as government risk as one can get, as well as wherever possible taking security against deposits loans that one makes. When leaving money anywhere, remember you are crediting somebody. What would you want to do with your own money if you could? Take charge over assets, lend with guarantee, have insurance from the more credit-worthy.
The credit spread has returned, and with vigor. A moving target shooting higher right now, destination unknown. Volatility? Volatile!
The price to insure has gone up rapidly, and the premium to cover ourselves against the “fruiter” has risen more acutely. The question remains – with deposits protected in the US, are we done with seeing three banks going bust? What does the CS acquisition/merger/bailout (depending on who you ask) mean for the Swiss and broader European and global financial system? The combined assets of the two global and systemically important banks coming in at 260% of Swiss GDP is a staggering and frankly scary number. The one certainty is that being prudent pays. In such circumstances where many are distracted or appear weakened, it can be more readily accompanied by further geopolitical tensions and maneuvers. While the cat is away…Without a doubt the best we can all do is remain optimistic but be prepared for the worst.
In EUR it continues to be made abundantly clear that the ECB is not done with inflation, remaining at the very core of policy. Not just in actions, hiking 0.50% in the midst of a banking crisis unravelling before its very eyes, but in words, even following the events of the weekend with a GFC-style closed room takeover out of hours. An important distinction that is applicable everywhere was made. The need to get prices back under control is of vital importance and does not, at least (only) in words (thus far), need to come at the cost of financial (in)stability. Brave words needing a thorough strategy and likely before very long action. The broad brush rate cut is not really a tool in this double-digit inflationary environment. The biggest concern for me right now is the volume of Italian debt in particular and the ability to either repay or roll said borrowings. Does anybody remember the lira? Anyway, despite the gloom, Vice President Luis de Guindos stated higher rates are positive for banks’ profitability. That explains why they are getting cheaper…?!
All eyes will be on Threadneedle Street, home of the Old Lady, or Bank of England, on Thursday. Bets have been pulled back on any hike this week, despite the cost of everything (including trains that don’t show up) increasing. As of Monday we are looking at a just over 50% chance of a hike. Memories of (recent) missed opportunities spring to mind; the Bank having been the first to hike in this cycle from the big 3 we cover, only to pause and then miss the boat. There was at least some good news last Wednesday from the Spring Budget. Chancellor Hunt has given us all a good reason to stay in work for longer. Appreciate Christmas seems to kick off earlier and earlier every year, but can we just get Easter out the way first please Jeremy! Sarcasm aside, GDP is still set to shrink in 2023, but considerably less than previously modelled, to almost a rounding error of -0.2 versus the prior print of -1.4%. We will also “technically” avoid a recession as negative growth will not be in consecutive quarters.
The US, in first place once again, is effectively bailing out. Three down, how many to go is the question now. Several regional banks continue to be in quite a pickle, rating agencies unhelpfully downgrading a number of institutions to junk right when they are trying to straighten themselves out. At least this time it wasn’t after the event (reminder: SVB was rated A2). Even $30Bn in deposits from those banks benefitting from those same outflows have not put a lid on it. Great timing for another Fed meeting to set interest rates on Wednesday. Just when you thought the job couldn’t get any harder. Just two long weeks ago we were talking about hikes taking the terminal rate to 5.75-6%. As of Monday the curve is unrecognizable. Not only is it not steepening, the implied rate is almost 100 lower. A 2% swing in the blink of an eye.
Courtesy of Bloomberg LLP
The biggest challenge now for policy makers far and wide must be how to achieve both price and financial stability. Historically cutting rates has been the norm when the system gets shaky. However, with inflation still in double-digits, or put another way 3/4/5 times higher than the target, this does not seem like the silver bullet we are looking for. More likely this is using a rushed financial band aid and a dose of Strepsils (other lozenges are available) to treat a broken leg – a la pandemic with an onslaught of Alphabetti Spaghetti acronyms to haunt all of us deciphering markets.