It is well known that it often takes years to build trust but only seconds to destroy it. This proverbial wisdom was painfully reminded to the global banking sector in March, so that at present also the non-word “financial crisis” is doing the rounds again.
The extent to which the financial system was or is under pressure in March is shown by the increase in the FED discount window shown below. This instrument allows commercial banks to obtain additional liquidity at short notice and thus avoid any liquidity bottlenecks in times of high uncertainty. The volume borrowed even exceeded the level of the great financial crisis and yet a financial crisis 2.0 would be too broad in our view. Unlike back then, the current crisis of confidence is based on individual cases and not on widespread problems in the banking sector.
Hardly any of us had heard of Signature, Silvergate or Silicon Valley Bank before the turmoil – the three collapsed institutions were active in the high-risk segment of start-up and crypto financing. A comparison with a universal bank does not seem appropriate in view of the narrow field of activity of the banks, but in the case of Silicon Valley Bank, it was still the fourteenth largest bank in the US and therefore one rightly wonders how it could have come to this.
One reason is definitely the relaxation of banking regulations for regional banks initiated by the Trump administration in 2019, which is now taking its revenge. Another reason is the business model itself – in the case of Silicon Valley Bank, the name said it all, because the institution benefited massively from the tech or startup boom in recent years and therefore grew almost ten times faster than the industry average. Obviously, the structures in the bank did not grow at the same pace, because viewed from the outside, the failure of risk management is otherwise almost inexplicable. Due to its concentrated business focus, SVB had over 90% of its deposits unsecured and was also invested in long-dated bonds on a large scale and without any interest rate hedging.
The massive interest rate increases of recent months caused the supposed book losses to rise enormously, so that the first large withdrawals of asset values set the ball rolling, or ultimately the bank run – the bank also had to realize accumulated interest losses in order to service the deposits. The withdrawal of $42 billion in a single day shows how quickly any mistrust spreads in the digital age (aided by social media). Even if the Fed was able to prevent a conflagration by taking the decisive step of guaranteeing all bank deposits for a limited period of time, uncertainty remains high and unfortunately it was not possible to prevent the crisis from spilling over into Europe.
As with the US institutions, the crisis at Crédit Suisse, which is rich in tradition, is also homemade. However, the major Swiss institution was not put in trouble by the latest interest rate hikes, but by a widespread loss of confidence that began years ago. The list of scandals Crédit Suisse has been involved in over the past few years is particularly long and could well be the subject of a detective story. Just remember the uncovered shadowing of a renegade manager, billions in losses due to windy hedge fund transactions, potential money laundering for a Bulgarian cocaine trafficker, or allegations of fraud against the country of Mozambique or a former Georgian prime minister.
The list could go on – in fact, Crédit Suisse lost its “credit” with clients long before the SVB, and recent events merely broke the already full camel’s back. It was thus a demise in fast motion, as is also vividly illustrated by the share price trend shown below, which ends before the collapse of SVB.
The now forced merger with the larger UBS would presumably have taken place over time even without the recent uncertainties on the market. Only time will tell whether the takeover becomes a particularly lucrative deal for UBS or a potential billion-dollar grave. For the financial sector, the elephant wedding was enormously important, because as a globally active and networked bank, Crédit Suisse was definitely systemically relevant and thus also “too big to fail.” The new UBS has already been dubbed a monster by the Swiss media – at 1.6 trillion euros, its total assets are more than double Switzerland’s economic output, which means that the monster bank will also potentially be “too big to bail out.” It is to be hoped that this is only a theoretical risk.
As already mentioned, the approach of the supervisory authorities in the USA, but also in Switzerland, was extremely fast and, above all, decisive. Greater damage was avoided as a result. However, the recent price turbulence at Deutsche Bank has shown that the crisis of confidence is anything but over. Central banks now face a particularly difficult task – in addition to the mandate of price stability and full employment, financial stability must now be maintained.
Was that it?
In light of the uncertainties in the financial sector, market expectations regarding key interest rate policy also changed dramatically. In the short term, there was speculation that the FED would no longer make an interest rate move in view of $600 billion in unrealized interest rate losses in the US financial system. Fed Chairman Jerome Powell even openly admitted that this option had been discussed in the run-up to the last Fed meeting – but high inflation and the solid labor market still justified a small rate hike of 25BP. Christine Lagarde, who also raised the key interest rate in March by a further 50bp to 3.5%, took the same line. In retrospect, both succeeded in cautiously tightening monetary policy without fomenting additional uncertainty.
A too abrupt halt to the key rate hikes would probably even have been interpreted by the market as an alarming signal with regard to the financial system and, moreover, the inflation dynamic has probably not yet been banished. Therefore, the fight against inflation has not completely receded into the background, but it is now no longer the sole and primary driving force behind the upcoming interest rate decisions. Regardless of this, the end of the interest rate hike cycle has in any case come closer.
This is also shown by the market expectations for the US key interest rate listed on the next page, which have changed massively within one month. Whereas at the beginning of March the market still expected a key interest rate of 5.5% at the end of the year, this fell to 3.7% immediately after the collapse of the SVB and most recently settled at 4.5%.
Whether the interest rate cuts expected in the second half of the year will actually materialize is doubtful in our view – but the central banks will have to become more cautious. On the one hand, the turbulence in the financial sector requires a more cautious interest rate policy and, on the other hand, banks will become more restrictive in lending on their own initiative in view of the high level of uncertainty. Even before the collapse of the SVB, banks were significantly tightening lending guidelines in both the USA and Europe, and this will continue with renewed momentum.
How strong the negative effect on the economy will be is difficult to assess, but recession risks have definitely increased in light of recent events. However, the global economy has proven time and again in recent months that it is now thoroughly crisis-proof. For seasonal reasons, the upcoming spring could well provide positive economic impetus, and the ongoing recovery in China will also provide additional impetus in the short term.
Conclusion: Better than expected
Notwithstanding the recent turbulence, both corporates and the global economy are currently proving to be extremely robust. Even a cursory glance at the capital markets would not allow any conclusions to be drawn about the recent increase in volatility – both global equities and bonds have been trading slightly higher since the turn of the year. In addition to the performance, the fact that bonds and equities are finally providing diversification in the portfolio again is also encouraging. However, the fluctuation intensity was enormous and is likely to remain high – a solid portfolio construction is therefore much more important than trying to chase daily developments.
As already mentioned, there is likely to be some sand in the economic gears, but the economy has been able to cope well with all crises recently.
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Prognoses are no reliable indicator for future performance.