Market Insights - March 20, 2023

On Friday, China’s central bank announced a surprise 25 basis-point (bp) cut to the reserve requirement ratio for banks. This liquidity injection is welcome at a time of uncertainty in global financial markets and confirms policy-makers’ desire to restart economic growth. It’s also a rare move to ease monetary policy in an attempt to stimulate the economy, running counter to the tightening carried out by other central banks.

Gold prices rose further as a result of the current uncertainty, nearing USD 2,000/ounce. Gold had shown no clear trend in recent quarters, so it’s reassuring to see that it has responded well to recent shocks and can still serve as a portfolio protector.

Despite the financial market uncertainty, the European Central Bank (ECB) decided to maintain its focus on inflation and raised its policy rate by 50bp to 3%. It also said that its policy decisions going forward will be based on economic data, which suggests that recent tensions in the financial system could prompt the ECB to slow the pace of its rate hikes or stop them entirely. 

Has a financial crisis been avoided?

Investors woke up with a hangover this Monday morning, after what was a busy weekend for Swiss banking authorities and the leaders of the country’s two largest financial institutions. In the end, an agreement was reached for UBS to acquire Credit Suisse at a fraction of the price it was trading at when the market closed on Friday. The very swift response by Swiss authorities, under pressure from the EU, was clearly intended to restore investors’ and customers’ confidence in the country’s second largest bank. Similarly, the guarantees and other credit lines that Swiss authorities granted to UBS are undoubtedly designed to reassure financial markets and prevent contagion to the rest of the banking sector. 

This time around – unlike with the 2008 financial crisis – banks are facing a problem of confidence rather than financial solidity. The capital ratios of Swiss and European banks on the whole indicate healthy, stable balance sheets that are nothing like what we saw going into the financial crisis that upended markets 15 years ago. It appears that the rapid, decisive action by Swiss and US authorities was enough to calm the investor panic that had rattled the banking sector in recent trading sessions.

However, we can’t ignore the fact that recent events will have ramifications for the global economy. Banks will certainly need to be more careful in granting loans, which will further intensify the current economic slowdown.

It’s also clear that recent events will be deflationary – just look at the nearly 12% decline in oil prices last week. And central banks will have to seriously rethink their plans for monetary tightening. The US Federal Reserve, in particular, which meets on Wednesday, has very few options: it can either pause its rate hikes or lift its policy rate by just 25bp, although markets were expecting a 50bp increase before the collapse of Silicon Valley Bank. This policy shift by the Fed should be a major boost to stock markets and help to restore investor confidence. Banking authorities appear to have learnt from the lessons of the 2008 financial crisis; developments over the next few days will tell us how effective their actions and measures have been this time.

The Swiss franc could lose its shine

Swiss banking authorities had a busy weekend. Saving a systemically important financial institution is no mean feat, especially if the institution in question holds assets equivalent to nearly two thirds of the country’s annual gross domestic product. Fifteen years after the rescue of another major Swiss bank, this incident once again raises the question of whether a small country, even one as rich as Switzerland, is capable of ensuring the stability of large systemic banks on its soil.

The risk is that the country could end up losing some of its wealth as a result. That could be what has driven the decline in the Swiss franc over the past few days, when it’s usually sought out as a safe-haven asset – especially in times of systemic crisis. The guarantees handed out by Switzerland’s banking authorities, and especially the cash injections offered by the Swiss National Bank (SNB), have also weighed on the Swiss franc internationally.

What’s more, the SNB is probably now hesitant to raise rates as much as it was planning to just a few days ago. The major reserve currencies typically used by central banks stand to benefit against the Swiss franc. The yen has held up well during this bout of instability, but the euro could be the one that delivers a more lasting outperformance.