A US banking crisis, a fed on pause, the ECB and Apple earnings
This week has been epoch-shifting, and we are still only on Thursday. On Wednesday the Federal Reserve hiked interest rates at its tenth consecutive meeting, lifting its main rate to 5-5.25%. This is the most aggressive hiking cycle for 40 years, however, there were some subtle shifts in the Fed’s statement that suggests that this could be the last hike for a while. Within hours of that decision and after Fed chair Jerome Powell said that the banking system is “sound and resilient”, and that financial conditions for the regional and mid-size banks had “broadly improved”, another domino fell, this time it was Pacific West Bank. Its share price tanked after it announced that it was looking at its options and exploring a potential sale. The Federal Reserve has done nothing to stem the banking crisis, which looks like it has intensified in last 24 hours, the regional banking index is down some 5% on Thursday. As we lead up to the Non-Farm Payrolls report that is due for release on Friday, the question now is, what matters more to the Fed: financial stability or fighting inflation?
The US banking sector on the precipice of disaster
Some are now arguing that this problem will continue to fester, and no US regional bank is safe if: 1, they have links to the tech sector, 2, they have a large uninsured deposit base and 3, paper losses on Treasury holdings. To make matters worse, the “sale” of First Century to JP Morgan last week wiped out shareholders, thus, while usually news of a takeover would help to stabilise a stock that is in trouble, instead, the threat of shareholders being wiped out is causing panic. Thus, the medicine for regional banks is almost as bad as the disease. At this stage, there is growing pressure on the US authorities to step up the level of guarantees for deposits held at all US banks, however, Dodd Frank rules will make this difficult for the FDIC to act unilaterally, and instead they may need the approval of Congress. Since the US Congress is embroiled in bi-partisan fights linked to the upcoming debt ceiling, they may not agree on a solution quick enough to deal with this problem. Thus, at this point, the banking system in the UK and Europe looks more stable than it does in the US, which is not something I thought I would be writing in Q2 2023.
The end game for the US banking crisis
The key question now is, what type of crisis is engulfing the US mid-size banking sector? In recent weeks it has largely been a crisis of confidence and one caused by deposit flight and dwindling liabilities. However, as this crisis drags on, it is no longer a crisis driven by deposit flight, but instead one that is driven by fear of the underlying assets on their loan books. For example, three quarters of Pac West’s loan book is in the property sector. When interest rates are rising and there is a threat of a recession, this is not a healthy place to have loans. If the Fed continues to hike rates to stamp out inflation, then we could see more stress on the asset side of these banks’ balance sheets and that is when this crisis could get nasty. We would also point out that First Horizon’s share price also took a beating on Thursday, after TD pulled out of a planned merger. Surely, banks only do that if they don’t like what they see during their due diligence process? Without decisive action from the US authorities this sector is being allowed to bleed out, which is a major risk to 1, financial stability and 2, the global economy.
The harbours in the storm
The market reaction to this ongoing crisis was interesting and is worth watching. While the stock prices of mid-tier US banks tanked, the wider indices held up well, considering. The S&P 500 fell some 0.7%, and the oil price managed to rally 0.7% after sharp declines in recent days. The big winner from the US banking crisis this week has been gold. It surged above $2000 an ounce on Thursday and reached a record high. The gold price is up more than 1.2% on Thursday and the mixture of momentum, a breakdown in the dollar and a strong fundamental case to buy gold could prove to be a powerful tonic for the yellow metal. Bitcoin may not have rallied on Thursday, but the long term case for bitcoin may be buoyed by the fallout from the US banking crisis.
Elsewhere, see our roundup of the other key events this week:
1, Fed meeting: a 25bp rate hike was delivered, as expected, however, there was some subtle shifts in language, which makes a pause likely. During his press conference, Jerome Powell said that he would not cut rates if inflation remained stubborn. However, the market has ignored the words from the Fed chair and has priced in a small pause and then a raft of rate cuts, 100bps of rate cuts are priced in between September and the end of January 2024. If the banking crisis deepens in the US, then we may see the market bring forward expectations for rate cuts to earlier in the summer.
2, The ECB: there is a divergence between the Fed and the ECB, with the market expecting the ECB to continue to hike interest rates this year at the same time as the Fed cuts rates. The ECB hiked rates by 25bps on Thursday and post the meeting, the market is expecting just under 60 basis points of further tightening between now and Feb 2024. It is rare for the ECB and Fed to diverge on interest rates for such a long period, thus, the economic data that comes in throughout Q2 will be critical to see if the market reassess and the two banks move back onto the same interest rate path. Right now, the divergence between the Fed and the ECB is positive for the EUR, and supports further weakness for the USD.
3, Apple results: The tech giant’s stock price has jumped more than 2% in after-hours trading on Thursday, as the market digests news that Apple has beaten EPS expectations, with EPS coming in at $1.52 for Q1 vs. $1.43 expected, revenues also beat expectations and came in at $94.8bn for the quarter. These earnings befit its title as the US’s largest company. The market seems willing to ignore the news that overall sales fell for the second quarter in a row, with the Mac and iPad businesses struggling due to continued supply chain issues. However, it saw a record high for iPhone sales and a record high in its service products. The market likes the iPhone news, which saw growth of 2% in the quarter, while the broader smartphone industry saw declines of 15%. Added to this, Tim Cook also announced a $90bn share buyback programme, which is like giving candy to a baby in the current market environment. These were solid results, the market is jittery, and it wants good news from a titan of American industry, it got that in these figures, and we could see a short-term bounce in the Apple share price as a result.