Global equity markets held up quite well last week considering the turmoil in the banking sector. The week started with the news of the failure of Silicon Valley Bank and Signature Bank in the US and ended with the takeover of Credit Suisse by UBS. The fallout from this will dominate markets this week and put the Central Bank meetings of the US and the UK (where they are due to decide on interest rates) firmly onto the back seat. The UBS / Credit Suisse deal was agreed last night and the details will be picked through and digested this week. The immediate concern for markets seems to be around the full write down of a certain type of bond holding (AT1) that was there as a regulatory buffer. The fact that these have been wiped out before equity will likely cause a repricing which in turn will increase the cost of credit. We would expect markets to remain choppy whilst these issues work their way through the market.
Last week
- Credit Suisse (and the banking sector in general) was the focal point for markets
- Global equities held up ok, but “value” markets (which have a higher weight to banks) such as the UK and Europe struggled
- Government bond markets did very well: yields fell to price in rate cuts and an increased chance of recession
- Credit markets sold off as higher borrowing costs were priced in
This week
- There is a lot to focus on this week but for the first time in a long-time news around interest rates and inflation will take a back seat as the Banks will remain the focal point for markets
- The US Federal Reserve meeting (which concludes on Wednesday night) is also a key watchpoint. It is expected that the Fed will hike rates by 0.25%. Markets will be wanting to see a change in tone from Fed Chair Powell and an acknowledgement that the Fed are now shifting their focus to ensuring market stability as opposed to fighting inflation through higher interest rates
- The Bank of England meet on Thursday where it is likely that they will maintain interest rates at 4%
- UK inflation data is released on Wednesday. It is expected (by Bloomberg economists) that UK CPI will come in at 9.9% (from 10.1%). UK Retail Sales data is also released on Friday
Equity returns are in GBP, Oil is in USD. Gold is shown in GBP. Bond returns are all shown in GBP. Source Bloomberg.
Last week in more detail
- This was a big week in financial markets. Having fallen by 27% through to Friday’s close, the weekend saw UBS agreeing to buy Credit Suisse for $3.2 billion; roughly 60% less than the price that Credit Suisse closed at on Friday. This marks a 99% decline from Credit Suisse’s peak in 2007.
- The Swiss National Bank has boosted their liquidity provision, to $108bn from $54 bn on Wednesday and has also granted UBS a c$10bn guarantee for potential losses from assets that UBS is taking over. Perhaps the most controversial element of the deal is the “bailing in” of bond holders, with c$17.2bn of Credit Suisse AT1 bonds written down to zero. This will likely be the biggest knock-on impact for other banks as it raises questions about the capital stack and will likely result in an increased cost of capital for banks which in turn will result in a tightening of credit conditions across the board. For background, AT1s were introduced after the Global Financial Crisis (as part of Basel III) as higher yielding bonds that sat between more traditional bonds and equity. The fact that they’ve been written to zero in this case (whilst the equity is still worth something) will create pricing pressure within other banks (as is the case this morning in the Asian markets).
- This concern about the banking sector and tightening of credit conditions has significantly increased the likelihood of recession which prompted a big rally in government bonds last week as lower interest rates were priced into markets.
- These opposing dynamics created some huge divergence within equity markets and sectors. “Value” type markets (or those with a higher exposure to banks) suffered, while “Growth” actually held up OK. For context, this resulted in the UK FTSE All Share losing 5.1% on the week (taking it into negative territory for the year-to-date), whilst the US S&P 500 returned 0.43% in GBP terms. Global share markets were down about 1.1% on the week in GBP terms which is less bad than one might have been expecting given the turmoil reported on the front page of the news wires.
- Despite the swift response from authorities and other banks, there has been an inevitable tightening in credit conditions. This has hit the credit markets, with borrowing costs going up. This makes recession more likely. Over the last few weeks (taking the month of March) we have seen investment grade credit spreads increase by about 0.5% and higher yielding credit spreads increase by about 1%. This has a direct knock-on to all sectors; all companies will now be having to pay more to borrow which in turn weighs on growth and makes recession more likely.
- One key positive last week was the performance of the bond market. UK 10-year gilts rose by about 2.8% and US Treasuries rose by about 1.6%. This rise came about as yields on these bonds fell (the price moves in the opposite direction to yield). This reflected a swift change in market pricing for interest rates. The bond markets are now pricing in about 1% of interest rate cuts over the course of the next year in the US markets and for the Bank of England to begin cutting rates by the end of the year (with just one more hike to come beforehand). The Central Bank meetings this week (Wednesday in the US and Thursday in the UK) will be absolutely key here in establishing if the Central Banks are going from the same playbook as the market.
- In other news last week, we saw the European Central Bank hike interest rates by 0.5% to 3%; this was fairly inevitable as they had promised it at their last meeting. However, their tone was much softer (European data has been really strong and they’d been emphasising the need for many more rate hikes) in that they said that future decisions would be “data dependent”.
- In the UK, we had the budget on Wednesday. This has been widely reported, with the key themes being more spending than expected, an extension of the energy price cap, expansion of free child-care and other reforms to get people back to work such as removing the lifetime allowance for pensions. This had minimal impact on the market as it was announced whilst the news around Credit Suisse was unfolding.
Credit Suisse’s share price dropped by 27% last week and fell by 75% over the course of the last year. UBS stepped in over the weekend and bought them at a further 60% discount to Friday’s closing price along with guarantees from the Swiss National Bank
The value of investments and the income from them can go down as well as up and you could get back less than you invested. Past performance is not a reliable indicator of future performance.
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