It has been another week where US regional banks have been in the spotlight, with First Republic Bank, as appeared inevitable this time last week, being taken over by the US banking regulator, the Federal Deposit Insurance Commission (FDIC)
The banks shares fell by a further 49% last Friday, and over last weekend, the FDIC ‘invited’ other banks to bid for First Republic, with J.P. Morgan paying $10.6billion to take on $92billion of deposits and “substantially all” assets including $173 billion of loan and $30 billion of securities. The FDIC will make available $50 billion of financing to J.P. Morgan and will take losses of around $13 billion. J.P. Morgan’s CEO, Jamie Dimon, said that “this part of the crisis is over” but noted a few other banks were at risk of the client withdrawals that have caused such turbulence in the regional banks. He noted that “down the road, rates going up, recession, real estate … that’s a whole different issue, for now we should take a deep breath”.
The failure of First Republic was the second biggest banking failure ever, overtaking Silicon Valley Bank. It seems strange to think that 3 of the 4 biggest US bank failures have all happened in the past 2 months. The volatility in the smaller banks has continued all week, with other banks viewed as vulnerable seeing their share prices taking a leg lower, not least after PacWest Bank, whose shares were already down 42% in the lead up to Wednesday saw its shares fall a further 50% yesterday on news that it was “reviewing its strategic options”.
We will likely see further failures over the coming weeks; the FDIC are likely to be very busy. Jamie Dimon’s point that this is all happening before we see the economic impact of rate hikes is also a very good one – bank balance sheets, certainly among the smaller banks of which there are hundreds in the US, do appear vulnerable if the US enters recession or issues in commercial property cause significant fallout and writedowns. The strongest banks in the US may well be getting ‘invited’ to do a lot more buying up of smaller banks in the coming year.
As expected, the US Federal Reserve increased interest rates, taking rates higher by 25 basis points to an upper bound of 5.25%, the highest level since 2007. We don’t need any reminders of what happened in 2008! The Fed also maintained quantitative tightening at a pace of $95billion/month. Policy decisions were unanimous. Fed Chair Jay Powell described as “meaningful” the decision to drop the line “some additional policy firming may be appropriate” but appeared keen to give the impression that a pause in policy rates at this level should not be taken as meaning rate cuts were imminent.
Powell said that the Fed is not expecting inflation to come down that quickly and “rate cuts would not be appropriate, that is why they are not in the forecast”. Powell has had advance sight of the Senior Loan Officer’s Survey which will be released next week – this is seen as a very important data point highlighting how the recent travails in the banking sector have impacted credit availability. His comments suggested the data is not very healthy, with Powell commenting that the issues in the banking sector are further tightening lending conditions and “those tighter credit conditions are likely to weigh on economic activity, hiring and inflation”.
Jay Powell did acknowledge a mild recession is possible, in line with the Fed’s own forecasts, but remained of the view that “the case of avoiding a recession is more likely than that of having a recession”. It would be a huge achievement to tighten policy this far and fast and manage to avoid a recession; certainly, the US leading economic indicators suggest a recession is a near certainty in the coming months. The big questions for markets are if we do see cracks in the data, how quickly the Fed will shift policy, and how much of an impact on corporate earnings we will see. Quarterly earnings reports show earnings are overall down year on year, but companies have ‘surprised’ and beaten expectations by previously managing those expectations lower. Profit margins are holding up better than expected as companies pass on price hikes to consumers, for now at least.
The European Central Bank also met this week and raised interest rates by 25 basis points to 3.25%. The meeting took place against the backdrop of the ECB’s bank lending survey showing the fastest pace of tightening in credit standards since the sovereign debt crisis in 2011. That said, future expectations were still robust. Weakening demand for credit was notable; this is no surprise given higher rates. The ECB warned that “the inflation outlook remains too high for too long” but repeated their “data dependent approach” to future policy changes. ECB President Christine Lagarde signalled that the seventh consecutive rate hike from the ECB would not be their last, saying “we have more ground to cover and we are not pausing, that is extremely clear”. Lagarde noted that raising rates by 25 basis points rather than 50 basis points reflected signs that credit conditions were tightening.
The economic data this week has seen the usual monthly PMI data, which again shows services numbers holding up well and offsetting continued weakness in manufacturing. This afternoon we will get the usual monthly update from the US jobs market with the Non-Farm Payrolls for April. We did see from the job openings data some signs that the US labour market is showing some (small) cracks with the lowest level of job openings reported since April 2021 at 9.59 million. This means there are 1.64 vacancies for every unemployed person – historically still very high but down from a peak of almost 2 vacancies per unemployed person last year.
There was a raft of data from the eurozone, with unemployment in April falling to an all-time low of 6.5%. Eurozone inflation data increasing slightly, to a year-on-year pace of 7.0%, up from 6.9%. Core inflation, however, eased for the first time in 10 months, to 5.6% in April from a record high of 5.9% in March. Eurozone growth remained positive in the first quarter, but only just, with quarter-on-quarter growth of 0.1%, below expectations, but a far better outcome that we could have seen had energy prices not fallen back so much. This left the eurozone economy with growth of 1.3% year on year.
Enjoy the long weekend. We’re going camping (our kids’ choice); having seen the weather forecast I know already this is a mistake!
Kind regards,
Anthony.
