What a week this was in terms of catastrophes. Bocconi’s mid-term exams came swinging. Inter, a team that a lot of you may support, knocked my beloved FC Porto out of the Champions League. The financial markets were in absolute madness. Disgrace after disgrace. But you know what? Chaos can be entertaining sometimes.
The topic of this week’s “Week at Close” was obvious until Wednesday – there was nothing else I could talk about: the collapses of SVB and Signature Bank. But the breath-taking pace of the last developments brought a new guest to the show: ladies and gentlemen, Credit Suisse.
Just last Wednesday, Jerome Powell gave his last speech in his Congress Testimonial, and the rhetoric was about whether or not should a 50-basis point interest rate increase be priced in by the market. He didn’t mention any financial stability concerns. Neither did anyone else, hence I am assuming no one knew about the possibility of this unfolding of events.
But then came Friday. The SVBoom. The biggest bank failure since… Lehman Brothers. I won’t explore the origins of this failure in depth, but in case you have not been following what happened, I will try to sum up the very basics: The Silicon Vally Bank, after record years of collecting deposits (most of them uninsured), started investing in the fixed-income space without hedging these positions. The surge in rates promoted by Central Banks all over the world made these investments turn into massive losses. Unable to raise new capital, depositors run on the bank, and it was game over.
The narrative was therefore completely reshaped during the weekend. On Monday, the 2-year yield on US Treasury notes was down a full percentage point (!) when compared to the level reached last week. The market completely priced the Fed out of interest rate hikes. And if the mismanagement of interest rate risk occurred in the US, the very same (or worse) could happen in Europe. The German 2-y yield opened the trading week 40 basis points lower, even with the majority of market participants expecting a 50-basis point rate increase by the ECB
As if all of this was not enough, then came Wednesday. Credit Suisse, a bank 5 times bigger than SVB. The stock was already down to start the week due to a new internal problem adding to the list of never-ending scandals: a delayed release of the company’s results. “Material weakness” had been found in their reporting.
But the market went in full force against the Swiss bank on the 15th, after a statement from one of its major investors: the chair of the Saudi National Bank, owner of around 9.9% of the company. He absolutely ruled out any further assistance to the bank in terms of capital injections.
This surprised a lot of people. Why would an investor that holds such a high stake say something that would obviously depress the price of the company’s stock? To be honest, I can understand why he rules it out: (1) just 3 months ago, the Saudi National Bank took part in a capital increase and since then, the stock fell a whole lot: almost 50%; (2) reaching 10% of ownership comes attached with some important regulatory standards that the Saudis wish to avoid. What is completely beyond my understanding is why he would say it publicly and so vigorously, at the worst timing possible.
You might imagine the consequences. We already know how the market works in such episodes. When an institution fails, it immediately starts looking at whom may be next. This happened in 08’, happened in the Euro crisis, and is happening now.
The psychology of the market, affected by the lack of confidence brought about by SVB, added strength to the fallout of Credit Suisse. The stock hit all-time lows and credit default swaps rocketed, deeply inverting the CDS curve. The market was, at one point, pricing a probability of default of almost 50%.
To backstop it, the Swiss National Bank had to intervene. Thursday, at 1h45 in the morning, the central bank of Switzerland announced it would lend up to 50 billion Swiss Francs to the company, to diminish any possible liquidity problems. This seemed to relieve the market a bit, but we are not free from danger.
The week ended with the Governing Council of the ECB raising its 3 key interest rates by 0.5% on Thursday. They followed their previous guidance: a 50-basis point hike was going to happen unless something “extreme” happened. The ECB didn’t flinch, considering the Credit Suisse situation not to be extreme enough for a U-turn. Poetically, it didn’t flinch on the day of the 1-year anniversary of the 1st Fed hike. Inflation is too hot, and it needs to be stopped. Now the focus is on whether Jerome Powell will do the same, or will instead stop hiking to prevent further systemic instability.
If you haven’t read last week’s article on the W@C, I suggest you do the exercise of looking at it and see just how much can the market momentum change in a matter of days.
We even got the US CPI report on Tuesday, showing a hot print on the monthly core component. The market didn’t move, at all! Could you have imagined such a scenario last week? No, you could not.
We entered into a dangerous place of policy conflict. The battle between inflation and financial stability risk is back, after its first appearance in October in the UK. Both risks have to be managed with limited tools, and next week’s Fed decision will be key.
Any action will be consensual. If the Fed hikes, it risks increasing the potential instability in the liquidity of the banking system. If it stops, however, the market may interpret the Fed to be worried about a confidence crisis, rather than one of liquidity. And if this is the case, keep your eyes open. Instability may be here to stay, and it can hit us hard.
A Portuguese attending the MSc in Finance, but still mentally preserved. Family, Basketball and Finance make my triangle of life. You won’t believe my deepest secret: I like to write.
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Gonçalo Almeida
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Gonçalo Almeida
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Gonçalo Almeida
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Gonçalo Almeida