The biggest feature of the last few weeks had been a ‘mini-banking crisis’ which threatened to develop into a global banking crisis. There is much commentary on this elsewhere but in a nutshell – Silicon Valley Bank (the 16th largest in US) collapsed along with 2 other US banks. The main cause of this was poor risk management in the face of higher US interest rates as, SVB particularly, had invested significant capital (customer deposits) into long-term US government bonds 18 months ago to achieve a higher return (bond yields were circa 1.5% at the time). As interest rates have risen over the past 18 months (to combat) inflation, SVB incurred significant capital losses on their bond holdings and did not have enough capital to meet customer demands to withdraw their money from the bank and a ‘run on the bank’ ensued.
Investors and markets wondered “who else had been swimming naked” which only becomes apparent “when the tide goes out” – Warren Buffet – with sharply higher (US) interest rates representing the tide going out.
Many banks fell 15-30% depending on the market perception of them and global stocks down 10% or so.
Banking and financial crisis is often about confidence as much as the hard facts.
The crisis spread to Europe with the major Swiss banking institution Credit Suisse needing rescuing by its Swiss cousin and competitor UBS in a bargain basement deal. That deal was agreed over a weekend to prevent a financial market crisis on the Monday. European rumours circulated soon after around Deutsche Bank but the situation stabilised.
Indeed, over the last 10 days financial markets have stabilised and equities have steadily edged higher as the situation appears to be under control but at the height of the crisis
-bank stocks down 15-30% (more for any bank in trouble)
-global stocks down 10%
-bond yields sharply lower as investors buy the safety of government bonds
-gold up to $2,000 per ounce as investors buy gold as a ‘safe haven’ asset
-oil down about 10% as economic growth was expected to be impacted
These trends have been reversed over the last 10 days but it is a fragile confidence that is returning.
The Big Question
This puts the US Federal Reserve and other global central banks in a very awkward position as
- All central banks had been sharply raising interest rates to combat a significant and stubborn inflation
- Rising interest rates causes strains in financial markets e.g. SVB
- Inflation is still not beaten e.g. it is still 5%+ in the US and 10% in the UK
- Have Central Banks raised interest rates enough?
- What if they have to raise interest rates more in a very fragile financial world?
- Could that itself lead to a financial crisis?
Central Banks will be studying the economic and inflationary data very hard ahead of their next meetings pondering not only all of the above but having to consider how much the mini financial crisis we have just had is itself a tightening move as investors and customers become more cautious?
Perhaps Central Banks have never been more on a knife-edge!