Financial market turmoil – 20-24 March 2023

Written by Andria Pichidi

Financial market turmoil dominated the markets last week and remains a hot topic as the various rescue plans are assessed!

UBS agreed to buy Credit Suisse in a $3 bln share deal. UBS shares were down 9.6% at 15.46 Swiss francs, while Credit Suisse shares dived nearly 60% to 0.77 francs. The agreement brokered by Swiss officials in a bid to prevent a wider crisis in the banking system includes extensive government guarantees and liquidity provisions. It still means losses for stockholders as well as around $17 bln of AT1 bonds, which will become worthless to ensure that private investors help shoulder the costs. That in turn is likely to see a revaluation of similar bonds issued by other banks, while it is threatening the stability of the market for similar European bank debt worth around a quarter of a trillion dollars. UBS said it plans to “downsize Credit Suisse investment banking business” and align it with its “conservative risk culture”. The government’s loss-guarantee, which foresees that UBS assumes the first $7 billion and the federal government the next $9 billion, was necessary because the hastily drawn up deal didn’t give much time to do due diligence and Credit Suisse has had to value assets on its books that UBS’ Kellleher said it plans to wind down.

The losses Credit Suisse’s AT1 debt holders are facing have sent a shockwave through the market. Those debt notes were designed to take losses in a scenario such as this, but the reminder that this can happen is adding to the fresh spike in risk aversion at the start of the week. 

On top of all this, on Sunday, global central banks announced an enhanced USD liquidity arrangement. The Fed, the Bank of Canada, the ECB, the BoE, the Bank of Japan and the SNB on Sunday announced “coordinated action to enhance the provision of liquidity, via the standing US dollar liquidity swap line arrangements”. The frequency of the 7-day maturity operations will be enhanced from weekly to daily as of March 20 until at least through the end of April “to support smooth functioning of US dollar funding-markets”.

In spite of the turbulence, the ECB maintained its tightening posture by boosting rates the 50 bps that had been flagged, albeit with considerable conditionality. We expect the same from the FOMC and BoE this week!

BoE Preview: UK inflation remains very high, and although the economy is looking slightly better than feared, core inflation remains a problem, especially against the background of a tight labour market. The government’s budget did focus on measures designed to try and entice inactive workers back into jobs, but the short-term boost to the economy doesn’t make the BoE’s decision any easier. Comments from individual council members already indicated that it will be another split vote, and Bank Angst will add to the arguments for caution, but on balance we still expect the BoE to slow down the pace and deliver a “dovish” 25 hike, unless market stress escalates further. Clearly, though, a further escalation of market volatility could still derail a hike and see the BoE taking a “wait and see stance” this week, especially after the prolonged series of rate hikes already delivered.

SNB Preview: After just being forced to make substantial liquidity provisions for Credit Suisse, the SNB will have to weigh the impact on financial markets against inflation risks. Like the ECB, the SNB is anticipated to stick with the plan and deliver another 50 bp rate hike, especially after official inflation forecasts were once again lifted last week. The State Secretariat for Economic Affairs (SECO) now expects prices to rise on average 2.4% (was 2.2%) this year. The projection for 2024 was left unchanged at 1.5%. GDP growth is seen at 1.1% this year and 1.5% next year, compared to 1% and 1.6% expected previously.

FOMC Preview: The meeting on March 21-22 is anxiously awaited, not so much for the rate action as a 25 bp is now the overwhelming bet, but for what Chair Powell says in his press conference and what the new SEP forecasts suggest about the rate trajectory and the economy.

The collapse of SVB, Signature Bank, and Silvergate, along with the concerns over First Republic and Credit Suisse, weighed heavily on investor sentiment. There was subsequent speculation that the FOMC would hold back on another tightening, not wanting to add to stresses. Indeed, Fed funds futures even erased forecasts for a hike and priced in 100 bps in cuts by year end. But believing no action would send a message of fear, and after the ECB stuck to its guns, the market repriced for a 25 increase. What the financial market turmoil did, however, was eliminate the chance for a shift back to an aggressive 50 bps move.

Fed funds futures are suggesting this will be the last of the rate hikes, however. Additionally, most economists have come around to the view that the tightening path for the major central banks will remain mostly intact given still elevated inflation and tight labor market conditions. However, it looks to be a shallower trajectory.

These circumstances will make Chair Powell’s press conference and the FOMC’s new dot plot and other projections crucial.

About the author

Andria Pichidi

Having completed her five-year-long studies in the UK, Andria Pichidi has been awarded a BSc in Mathematics and Physics from the University of Bath and a MSc degree in Mathematics, while she holds a postgraduate diploma (PGdip) in Actuarial Science from the University of Leicester.