Both US and European bank stocks dropped sharply following the collapse of Silicon Valley Bank. But we think European bank stocks are in a better position than their US counterparts – they are well capitalised, their books value is higher, and their customer deposits continue to grow.
Gold, buoyed by the recent uncertainty, rallied to almost USD 1,900/ounce. Gold prices have shown no clear trend in recent quarters, so it’s good to see that they have been lifted by recent shocks and can still serve as a portfolio protector.
The current tensions in the US banking sector may be overshadowing the upcoming release of US inflation figures for February. However, we still expect consumer price growth to continue to return to more normal levels relatively quickly.
The weakest link in the economy has broken. What will the Fed now do ?
Not all of the US Federal Reserve’s rounds of monetary policy tightening end well, especially when they involve a long series of rate hikes, like this one. Increasingly tight lending conditions, and the resulting liquidity squeeze, can create insurmountable financial difficulties for some economic agents. This time around, Silicon Valley Bank (SVB) could well turn out to be the weakest link in the chain – the first to succumb to the pressure of overly restrictive financial conditions.
The Fed cannot ignore this signal. In the banking sector, it’s so important to ensure depositor trust in order to prevent panic that could spread to other players. This time, the authorities’ swift response, particularly the decision to fully guarantee SVB customers’ deposits, should be enough to contain any risk of contagion and prevent a rerun of 2008.
This incident should also put an end to the Fed Chair’s ongoing hesitations. Perhaps Jerome Powell is just not a great communicator, or perhaps investors still haven’t grasped the subtleties and nuances of the language he uses, but it does seem strange that last week he said that interest rates could head higher than previously expected. After the Fed’s last meeting just a few weeks ago, he had hinted that rate hikes might be put on hold.
The Fed is set to meet again on 22 March, and it’s still unclear whether it will hike rates then or not. But let’s hope that Mr Powell will have weighed up the risks and realised that a break in monetary policy tightening is needed quite soon so that the effects of the Fed’s sharp tightening over the past year can be taken in.
It’s widely recognised that it takes a few months for the impact of rate hikes to be felt on economic activity. The US bond market has already made up its mind and seems to be warning the Fed of the threat of a monetary policy mistake. The yield curve is already sharply inverted, and long-term yields lost considerable ground last week.
Japan – sayonara to deflation
The Fed is not the only central bank that’s having to weigh up the risks of tightening monetary policy. Across the Pacific Ocean, Kazuo Ueda, who will become the governor of the Bank of Japan (BoJ) in April, will have some equally tough and economically crucial decisions to make. The new BoJ boss is seen as less dovish than his predecessor Kuroda, although he may still hold off on normalising monetary policy. But a gradual tightening of lending conditions seems inevitable at this stage. Ultra-accommodative monetary policy and asset purchases no longer make sense when inflation is over 4%, which is double the bank’s target rate.
But what impact will all this have on the stock markets? Gradually rising interest rates are likely to push up the yen against the US dollar. That trend should continue, given that expectations of the Fed’s next moves are likely to change, which will no doubt have an impact on the interest rate spread.
Like in the US, rising interest rates will hurt high growth sectors, and a stronger yen will weigh on exporting companies, although the yen will be rising from historically low levels, which should help to limit the damage. At the same time, banking stocks could continue to be boosted by higher interest rates. And some domestic consumer stocks, which are less dependent on the yen and long-term rates, should rebound, thanks to the uptick in wage growth, which is forecast to reach over 4% – its highest rate since 1995 – and the return of Chinese tourists to Japan.
So a lot will depend on Mr Ueda’s monetary policy moves and his communication skills, which we hope will be better than those of his US counterpart. But in any event, the evil inflation genie seems to be out of the bottle for good and Japan is unlikely to see deflation again any time soon.
Author
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Daniel Varela holds a degree in business administration with a specialisation in finance from the University of Geneva and began his career in 1989 as a fixed income manager. He joined Banque Piguet & Cie in 1999 as head of institutional asset management and with responsibility for bond analysis and management. In 2011, he became head of the investment strategy and Piguet Galland's investment department. In 2012, he joined Piguet Galland's Executive Committee as CIO.
