16 Mar Honey I Broke The Banks
Events are moving quickly in our highly ‘financialised’ markets with rising concerns around global liquidity, as evidenced by the sell-off in Credit Suisse and other European banking shares.
The views expressed below have not changed.
Australian Banks are well capitalised and the market is experiencing more of a “sell now, ask questions later” scenario as investors position in more defensive assets like US Treasuries and Australian Bonds.
Weaker commodity prices are also discounting slowing global economic growth, which is not to the benefit of Australia’s resource heavy share market.
What a difference a week makes
From Federal Reserve chairman, Powell, spouting higher rates for longer at a Senate Committee hearing in early March, to the collapse of three US regional banks the week after and forced intervention by the Fed and other agencies to stop the contagion impact of failing financial institutions.
What happened?
Well, that’s easy to explain, Powell and the Fed have raised interest rates at the fastest pace since 1981 and openly invoked the often referred to “inflation slayer” Paul Volcker. In in doing so they have ended up breaking parts of the financial system.
The collapse of three regional banks, which are not regulated to the same degree as the larger national behemoths like JP Morgan, Bank of America, and Wells Fargo, probably did not come as a surprise to many experts.
The pace and the magnitude of rate rises was bound to expose vulnerabilities and fragility in the system at some point. And, as per usual, the sound of breaking glass was inevitable, experts just didn’t know from which skyscraper it would come.
The complexion of the three regional banks is similar, two were crypto lenders, namely Silvergate and Signature Bank (listed) while SVB or Silicon Valley Bank (listed) was the largest lender and depositor for technology start-ups.
These institutions failed the first hurdle of banking risk management – matching their assets and liabilities — meaning once depositors got whiff of the fact that SVB could only repay deposits if they realised losses on their assets, then it was all over bar the shouting and regulators had to step in.
Unlike 2008, this was not a creditor problem (bad debts) rather a liquidity problem.
Of course, rising rates exacerbated the issues, but on balance, the failures, yet again, come down to risk management and regulatory flaws.
Recession ahead and the pivot
In one-week, financial markets have moved from pricing in a Fed rate outlook of 4.76% in May 2023 to 3.75% by January 2024.
Yes, that is correct, 100bpts of easing by the start of next calendar year, or is it?
It remains to be seen whether the Fed is so accommodative and, for what it is worth, I suspect Powell will take his cue from the data, i.e., will the US economy now slow post the bank collapses, as other banks shore up their balance sheets and scale back lending; will the consumer duck for cover and start saving again? Is a credit crunch on the way? And will deflation not inflation become the demon (again!)?
The February 6% annual inflation reading didn’t lend support to the Fed pivot/rate cutting camp, thus a 25bpt rise in the Fed fund rate looks likely to occur at next week’s meeting.
Only time will tell, but the worst outcome which investors should fear, is sustained high inflation and faltering growth, the dreaded ‘stagflation’ that haunts those old enough to have lived through the 1970s.
For the time being, here in Australia, we can sit back and watch the share market volatility as investors fear further contagion in the US and global banking systems, as well as the spectre of looming recessions in the US and possibly here too.
Usually there are more cockroaches to come out of the cupboard, even when only a few have been spotted, so the unravelling of the regional banking crisis may take some time to unwind.
Ironically for all the criticism the head of the RBA, Lowe, has received, he may now be looking smarter for adopting a slower pace of interest rate rises in Australia.
Central banks will be continuing to calm financial markets, restore confidence and, depending on how credit markets hold up, they will be looking to the data to establish where monetary policy and interest rate moves go to from here.
Three quarters of the way through the cycle
Again, opinions are like noses, everyone has one. So here is mine.
I think the bank failures are on balance a good thing, as the excesses of zero interest rate policies are squeezed out of the system. More regulatory oversight will hopefully be coming (post the relaxation from former President, Donald Trump) and as I write Senator Warren has introduced legislation to repeal the 2018 deregulation measures.
For those share and bondholders’, the losses are not palatable but in a rising interest rate environment risk management is key for either you as an investor or the financial institutions we invest and bank with.
Shareplicity has remained defensively positioned in terms of stock selection (think healthcare, defensive consumer staples and even a long US treasury ETF) with cash on hand for these pullbacks. Once the dust settles it will be time to put some more money to work.
However, the collapse of a few banks is most likely, merely, the start of the tremors in our economies and given the lagged pace of interest rate rises, it may take a few months for the true extent of the damage inflicted by central banks to emerge in terms of economic slowdowns.
Some exciting news
On March 21 I will be joining AusBiz (business tv) as an anchor in yet another step in the Shareplicity journey.
I am hoping this will enable all of you who want to know and learn more about investing on a day-to-day and weekly basis to now catch me at www.ausbiz.com.au.
Sign up to the newsletters and I will be sharing my thoughts.
For now, this will be in the last BLOG post for Shareplicity so I hope you will stay in touch via Twitter and Linkedin and join me at AusBiz at the beginning of April when I will be appearing from 3.15-4.15pm.
Thank you for your support and please see a couple of recent stories I contributed to for the ABC and FNArena.
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