Pressure on two banks in the US and Europe has increased market volatility over the last week, and led to global equity markets giving back gains made so far this year. Whilst it is disappointing to see the solid start to 2023 interrupted, we don’t believe the issues behind the bank failures are likely to lead to contagion and a repeat of 2008/9, when the banking sector as a whole faced a liquidity crisis.
A social media fuelled bank run
Silicon Valley Bank (SVB), which was the 16th largest bank in the US, became the highest profile bank failure since 2008, when regulators stepped in to take over the bank and guarantee depositors on 13th March. SVB, despite being little known outside of the tech sector, was popular with tech start-ups, and as deposits increased with the bank, SVB started buying longer dated Treasury Bonds with their capital. Following the rapid rise in US interest rates over the last 12 months, Treasury Bond yields have also risen, which has caused the price of Treasury Bonds to fall, in particular longer dated issues, which are more reactive to changes in interest rates.
Depositors became spooked, with some reports suggesting that the rapid spread of information across social media drove concerns over the bank’s stability. SVB were forced to sell the Treasury Bonds they held at a loss to the price paid, and concerns grew, with $40bn being withdrawn by savers over two days.
Unlike the Great Financial Crisis of 2008/9, where cracks could be seen appearing for some time, regulators had little warning that SVB was in need of a bailout. However, learning from the mistakes made almost 15 years ago, regulators acted quickly to reassure depositors that their funds were safe, and the Bank of England and Treasury acted with speed to rescue the UK arm of SVB, brokering a sale of assets to HSBC.
Two other smaller US banks have also ran into difficulties over recent days. Signature, who were based in New York, saw a similar run from depositors, and First Republic, who are based in San Francisco, received a $30bn cash injection from major banks including JP Morgan and Bank of America.
It remains a possibility that other small and mid-sized US banks could follow down the path of SVB, Signature and First Republic, although we feel reassured that regulators have acted swiftly to resolve the potential for contagion.
The impact of central bank policy
The demise of SVB has in part been led by the aggressive interest rate increases we have seen since the start of 2022. Central banks have been laser-focused on tackling inflation over the last year, and by hiking the central bank rate from 0.25% to 4.75% in the space of twelve months, the US Federal Reserve has raised interest rates more quickly than at any point in history. In some respects the Federal Reserve were correct to focus on the inflationary pressures, as high inflation over the long term can cause serious economic damage. However, the actions taken by central banks, including the Bank of England and European Central Bank amongst others, have wider consequences in terms of financial stability.
The European Central Bank raised interest rates by 0.50% last week and we expect other central banks to nudge rates a little higher, although we do not believe significant further increases are warranted. Indeed, with inflation falling sharply – the Office for Budget Responsibility has suggested UK Consumer Price Inflation would return back to 2.9% by the end of this year – central banks run the risk of going too far, and could begin cutting rates as we move into 2024.
Credit Suisse
Away from the US, the continued woes at Swiss bank Credit Suisse has added to the negative market sentiment. Credit Suisse’s shares has been under pressure since 2021, after being hit by a number of scandals and compliance failures, although the downward stock price movement accelerated following the news of SVB. The Swiss central bank agreed to lend Credit Suisse $53bn last week to shore up their operations, following the news that the bank’s largest backer, the Saudi National Bank, wasn’t prepared to add further support.
It is important to acknowledge that Credit Suisse have been under pressure for some time, and whilst the very recent market malaise hasn’t helped Credit Suisse’s cause, there is little to link the Swiss bank’s issues to those faced by SVB and others in the US. That being said, unlike the three smaller US banks that have run into difficulties, Credit Suisse is of much greater importance to global financial stability. As a result, regulators worked to arrange a deal for the bank to be sold to another Swiss bank, UBS, which appears to have been successful in calming market fears.
Reasons to be positive
Away from the specific issues facing the banking sector, it is important to recognise that the global economy is in reasonable shape. Despite the unexpected jump in UK Consumer Price Inflation reported for February, we expect inflation rates in most Western economies to fall rapidly, and this should lead to Central Banks pausing the rate hiking cycle, and potentially performing an about face as we move into 2024. In the Budget last week, Chancellor Jeremy Hunt suggested the UK economy should avoid a technical recession this year, confounding previous negative predictions. Corporate earnings remain resilient, with US companies on average reporting better than expected results in the Q4 2022 earnings season. Finally, stress in global Bond markets has eased, as investors believe central banks will change direction in due course.
Despite the fact we have seen the useful gains made during January and February given back over the last week, we do not see the specific issues in the banking sector leading to wider contagion across global banking stocks. The underlying economic outlook is proving to be stronger than anticipated, and whilst markets are likely to be volatile in the short term, our positive view over the medium term remains intact.
Speak to one of our experienced financial planners here if you have concerns about how your portfolio is positioned in light of the news in the banking sector.
The value of investments and the income they produce can fall as well as rise. You may get back less than you invested. Past performance is not a reliable indicator of future performance. Investing in stocks and shares should be regarded as a long term investment and should fit in with your overall attitude to risk and your financial circumstance.
