Insight

Banking Sector Update

Banking Sector Update

While the recent rescue of a Swiss bank may directly address that particular bank’s problems, it’s clear that the global banking sector remains fragile. It’s possible that more financial institutions may face problems in the near-term, we are certainly not out of the financial woods yet.

The banking incidents in the US and Switzerland highlight just how important confidence is in the financial sector and how vulnerable institutions can be once customer confidence is lost. Bank failures in the US and the forced merger of two banking giants in Switzerland have only served to fan investor anxiety.

This past week, a consortium of large US banks deposited USD 30bn at a regional California-based bank to shore up confidence.1 Regional bank shares have fallen 30% since March 1st and Moody’s recently cut its outlook on the US banking system to negative.

Implications on the banking sector

On the plus side, governments are actively responding: central banks around the world, led by the Federal Reserve Bank, European Central Bank and Bank of England have recently announced further liquidity measures. Even the People's Bank of China has surprised with a cut to the reserve requirement ratio.

The Federal Deposit Insurance Corporation (FDIC) and US Treasury Department recently announced that all depositors from Silicon Valley Bank and Signature Bank would have full access to their money, implying that all depositors at US banks wouldn’t be subject to a banking default.

While it’s not clear whether the US government is providing unlimited deposit insurance and for how long, their actions should shore up confidence in the near-term.

Recent media reports that the US is studying ways to guarantee all bank deposits should provide a boost to market sentiment.2

Markets are looking for a scapegoat for the recent banking turmoil, and blame can largely fall on the Fed’s abrupt and rapid reversal of its monetary policy path. Following significant pandemic-related fiscal and monetary stimulus, the Fed and ECB have abruptly reversed course.

The Fed has raised interest rates by 450bps in 2022, leading to the worst 60/40 (equity/bond) performance since 1931. All eyes are on the Fed’s Federal Open Market Committee meeting on the 22nd March, with the market discounting the Fed to raise its benchmark rate by 25bps to 4.75-5.00%.3

I believe it’s highly likely that the Fed will directly address recent banking incidents with more measures to stabilize the banking sector and could even announce a pathway to pause rate hikes.  

Investment implications

Putting all of this together, I believe market participants should anticipate some negative spillover effects the broader economy.

I expect interest rates that banks pay depositors are likely to go up while US Treasury rates and other government bond rates will fall as depositors become more aware of their available rate and risk options.

This should place downward pressure on banks’ net interest margins that could drive more consolidation in the industry and less credit expansion in the economy.

We continue to be in a contractionary part of the economic and market cycle and the recent banking crisis reinforces this view.

Despite the strong US non-farm payroll gains and the overall labor market, it’s becoming very clear through the recent banking emergencies that the Fed’s tightening cycle is starting to take a toll.

We know that monetary policy has around a 12-18 month lag and so I expect certain segments of the economy – such as small cap companies without easy access to liquidity - to start feeling the impact soon.

I favor defensive assets such as cash, short-term government bonds, investment-grade and gold. 

Reference:

  • 1

    Source: CNN, March 17, 2023

  • 2

    Source:https://www.bloomberg.com/news/articles/2023-03-21/us-studies-ways-to-guarantee-all-bank-deposits-if-crisis-expands

  • 3

    Source: CME FedWatch Tool 

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