6 Key Market Insights from April…

Here are six current financial & banking trends that you should be aware of.

April 27, 2023
6 Key Market Insights from April…
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Matt Crabtree

Written By

Matt Crabtree

 
  • Recent market volatility has been alarming. 
  • Which begs the question, where are we now? 
  • And where do we plan to end up? 

Our team has uncovered several insights… 

1. What this means for the banking industry as a whole, and what comes next.

Concerns about the effects of aggressive monetary policy tightening have struck the global banking industry hard. The financial markets were quite volatile in March, but the pressures there have now subsided.

Banks in the United States are rapidly depleting their liquid assets due to large withdrawals of deposits from smaller regional lenders and unrealized losses on their securities holdings. Three regional banks have failed as a direct result of these problems.

Silicon Valley Bank and Signature Bank properly safeguarded all depositors (even uninsured depositors), while owners and some debt holders were not.

Uncertainty among depositors and the financial markets has been exacerbated by US Treasury Secretary Janet Yellen's statement, which has been perceived as quite inconsistent on the prospective handling of uninsured non-systemic bank accounts.

Yellen has said that comparable measures may be used to insure deposits at smaller banks in the United States to safeguard the banking system, but at this time, no such comprehensive insurance on deposits is being explored.

Credit Suisse had to combine with UBS since UBS was the stronger local opponent in Europe. As far as we’re concerned, Credit Suisse’s issues predate the recent developments in the United States and are more internal to the corporation.

Its fortunes turned for the worst in the latter three months of last year due to significant withdrawals of customer funds and deposits, which accelerated as market sentiment worsened.

What this means for banks… 

Most European financial institutions feel the effects of these happenings via the more cautious market mood. Primary bond markets shut down as debt risk premiums expanded due to volatile financial markets.

As banks go forward with their financing programs, the effect of larger spreads, which make it more costly for banks to finance their operations, will become apparent. Bond markets have recently opened to some extent.

The AT1 market took a major blow when Swiss authorities decided to wipe out Credit Suisse AT1 debt holders. Banks are unlikely to be able to issue new AT1 anytime soon, which raises the possibility that existing AT1 notes may be extended. 

According to our analysis, the recent developments in the banking industry have significantly raised levels of uncertainty, which will likely be reflected in significant short-term volatility in credit markets for the foreseeable future. 

What comes next…

We anticipate a broad and longer-term effect on bank spreads across bank capital and bank senior debt as investors factor in additional uncertainty over resolution methods.

2. This is neither a repeat of the 1980s savings and loan crisis or a second coming of Lehman Brothers.

Despite the USD, Euro, and GBP struggling, the trouble has so far only affected a small number of regional banks in the United States and a single, particularly weak European institution.

The Swiss government and central bank were quick to intervene, and the problem in Europe has been mitigated to a large extent as a result. Non-systemic banks in the US are where the most of the trouble is, although bigger banks may have profited from increased deposits and commercial opportunities brought in by their systemic position. 

This significantly reduces the possibility of a widespread systemic disaster. A more dramatic stabilisation in bank credit spreads would, in our opinion, be essential for a stabilisation of deposit trends in the United States.

There has not been any stressed-out firm with as much impact on the international financial sector as Lehman Brothers. It is possible that more institutions have the same symptoms as those under pressure in recent weeks, but a domino effect similar to 2007–2009 does not seem plausible.

Tightening lending requirements… 

We are still in the preliminary phases, therefore there is a lot of room for growth and improvement. The entire effect of recent events in the United States has yet to be felt, even though the crisis seems to have been controlled for the time being.

In view of the results of the Federal Reserve's Senior Loan Officer survey, it is clear that financial institutions have tightened their lending requirements significantly. 

Because of the shrinking deposit base of small and regional banks and the recognition by regulators that they need to adopt a more proactive approach, there is now a possibility that lending conditions may tighten even more, making banks even more cautious.

The importance of small banks (those with assets of less than $250 billion) to the US economy has grown since 2008, when they accounted for just 30% of all commercial bank lending.

Large banks may not be able to fully fill the hole if they withdraw. In addition, smaller financial institutions are responsible for more than two-thirds of all commercial real estate financing and more than one-third of all residential real estate (How To Invest In Real Estate) loans. 

If these asset prices continue to collapse, it might put further pressure on the already fragile balance sheets of smaller and regional banks.

3. Significant issues awaiting Europe.

As faith pours away from stocks into hard commodities like gold, regulation of big European banks has become considerably more stringent since the financial crisis and the euro crisis.

Clear improvements in transparency, stress testing, and oversight have resulted from the Single oversight Mechanism and the work of national financial regulators. The Single Resolution Mechanism will also aid in severing the fatal connection between sovereigns and banks that exacerbated the euro crisis.

Capital and loss-absorbing buffers are high across Europe's banking sector. These provide financial institutions with a buffer against the effects of deteriorating credit quality. There are strict liquidity (LCR) and longer-term financing (NSFR) standards that banks must fulfill. As a result of these features, the system is resilient to adverse shocks.

Before the recent string of unfavourable events, European banks had already raised a record-breaking amount of debt across covered bonds and unsecured debt from capital markets this year. Banks will be better able to ride out the temporary shutdown of main debt markets as a result of this. 

However, the majority of the TLTRO-III money made available to banks by the European Central Bank will expire in only three months on June 30. The procedures taken to provide banks with collateral relief during the Covid-19 crisis are also expected to tighten. 

What the ECB may do… 

The European Central Bank (ECB) may decide to provide banks with more liquidity by resuming (T)LTROs and/or reducing collateral requirements again if further disruptions occur in bank funding markets.

4. Stricter financing requirements, reduction in larger ticket goods purchasing.

So far, financial pressure in the Eurozone has only intensified somewhat. In the days after the market upheaval, the ECB's own gauge of systemic stress rose, although only to levels not seen since the beginning of the year.

We saw a much larger increase in stress due to the situation in Ukraine and the beginning of the hiking cycle than we had previously experienced. Because of economic worries and rising interest rates, lending standards have tightened.

Recession fears (Dave Ramsey’s savings advice) and rising interest rates have already led to tighter loan conditions before recent events. The present financial turbulence is having an effect, as a recent poll conducted by the ECB found that banks expected to further tighten standards in the months ahead.

If CDS spreads continue to widen for banks, financing costs would rise, which might ultimately lead to increasingly stricter lending standards.

The Federal Reserve's Senior Loan Officer survey is the most popular barometer of U.S. economic health, but other data points, such as the Small Business Optimism Index from the National Federation of Independent Businesses, are also worth considering. Both “expected credit conditions over the next 3M” and “availability of loans compared to 3M ago” are subcomponents. 

This is slowly but surely deteriorating. Lending to commercial and industrial firms also shows monthly fluctuations, with February showing the first monthly fall since September 2021. Even though it is up 12% year over year and 20% from 2019's levels, we will be keeping a close check on this.

Slowdown: less loan availability together with less willingness to buy…

The risks seem to be on the negative as a result of increased rates, fewer loan availability, and declining business sentiment. We can see that consumer demand for mortgages to finance house purchases has dropped by more than half. Even while consumer credit metrics are currently looking good, growing default rates on auto loans are a warning flag. 

The newest consumer mood data indicates a decline in the desire to purchase ‘large ticket goods,' such as cars, real estate, and major appliances. As a result, we anticipate a slowdown in consumer borrowing, particularly if consumers become fearful that their savings are at risk.

5. ING's baseline economic projection.

Already more conservative than the mainstream, our current base case accounted for the negative effects of the quick tightening of monetary policy. It seemed inevitable that the financial system or the actual economy would experience some kind of breakdown.

Whatever the situation may be, recent events have bolstered our expectation of a US recession and muted growth in the Eurozone. The risks are now more evenly distributed; when they were previously obviously tilted to more resilient growth and higher central bank rates.

Up until this past month, energy prices and monetary policy were the primary factors in determining the various scenarios; currently, however, credit conditions or lending standards and the soundness of company balance sheets are the primary factors in determining the various scenarios.

As a result of increasingly stricter lending restrictions, the likelihood of a technical recession in the Eurozone has grown once again. Bank lending rates are expected to grow further despite the fact that risk-free interest rates have fallen.

However, given the Eurozone's heavy dependence on banks, corporate borrowing from the bond or stock (Top Stock Trading Apps) markets is still not anticipated to significantly alter the financial landscape. 

While some financial strain might help reduce inflation more quickly than predicted, excessive financial strain would cause a recession in the Eurozone. There has not been much concern about a repeat of the euro crisis so far. Longer-term financial hardship, however, obviously raises the possibility of yet another euro crisis.

A harsh landing for the US economy is more likely if borrowing prices rise and credit availability decreases. Inflation will fall more rapidly as a result of this policy change. We have long forecasted that rate decreases would dominate the second half of 2023, and we now favour an easing of 100 basis points in the fourth quarter of this year.

6. All eyes are on the central banks.

Virtually all central banks adhere to the adage that monetary policy and financial stability are separate issues that need distinct policy responses.

It is true that central banks like the Federal Reserve and European Central Bank have become more nimble at developing and implementing tools to unblock specific areas of the financial system; for example, in March 2020, they helped money market funds deal with difficulties, and at the end of 2017, the UK's Bank of England temporarily purchased government bonds to stabilize LDI pension funds, not to mention their 2022 intervention

What the central banks have been up to…

Central banks, led by the Fed, have been fast to act with fresh initiatives to alleviate the market turmoil. However, the current market turmoil is unique in that the increased interest rate environment is the major culprit. Because of this, it will be difficult to separate the challenges of financial stability from the choices of future monetary policy.

Tighter credit conditions and falling bank lending, as noted by Fed Chairman Powell following the March FOMC Fed rate decision, would have the same effect as rate rises.

This essentially implies that central banks will be keeping a careful eye on whether tighter financial conditions have been established as a result of banks becoming more cautious as a result of the present turbulence. If that is the case, private banks will be performing the central bank's heavy lifting, which might lead to peak rates being reached sooner.

Rate rises obviously have an effect, and the policy environment is rather restrictive. In the same way that central bank doves were unwilling to abandon their “transitory” inflation forecasts during Covid-19, inflation hawks today may find themselves in a similar position.

In light of recent developments, officials are expected to speak out more forcefully against the rising interest rate's dual threats to economic growth.

Takeaway

We anticipate a final 25bp rise from the Fed in May, bringing the Fed funds range to 5.25% from 5.20%. Higher borrowing prices and reduced credit availability are two major ways in which financial difficulties ripple across the economy at large. 

We also anticipate a rate drop by the Federal Reserve of approximately 100 basis points in the fourth quarter as the likelihood of a hard landing rises and inflation is expected to fall as a result. The resulting target range for the Fed funds rate would be 4.00–4.25%. In 2024, we anticipate interest rates to reach 3%.

The European Central Bank has begun the last wave of rate rises in response to recent financial concerns. The European Central Bank (ECB) will likely raise interest rates again in May unless circumstances deteriorate significantly, at which point a 25 basis point increase seems most likely. 

The European Central Bank is expected to adopt a “wait and see” posture after its last rate rise of 25 basis points in June. We do not anticipate a rate decrease from the ECB until the latter half of 2024, while core inflation remains persistently high.

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