March 21st Financial News

Daily News

Summary:

U.S. First Republic Bank shares take a big dive; Lagarde: Market turmoil won't hinder ECB's anti-inflation battle; Nick Timiraos: Fed faces tough decision on rate hike...

【Quick Facts】

1. First Republic Bank's share price took a big dive.

2. UBS to buy Credit Suisse sparked concern among Swiss political parties and public opinion.

3. Lagarde: Market turmoil will not hinder the ECB's anti-inflation battle.

4. The Swiss government committed a total of nearly 260 billion Swiss francs in public funds to bail out Credit Suisse.

5. Nick Timiraos: The Fed is facing a difficult decision on the issue of interest rate hikes.

6. JPMorgan Chase is leading efforts to develop a new rescue plan for First Republic Bank.

7. In the face of the industry crisis, the British government continues to consider relaxing banking rules.

【News Details】

1. First Republic Bank's share price took a big dive.

First Republic Bank shares plunged nearly 50 percent on Monday, less than a week after major U.S. banks injected $30 billion in deposits into First Republic Bank, as investors sold off the bank's shares over concerns that the injection was not enough and a second bailout would be needed to keep operations afloat. S&P Global Ratings also downgraded the bank to a deeper junk rating on Sunday, saying there were liquidity risks.

But UBS's state-backed acquisition of Credit Suisse pushed bank shares higher across the board. European bank stocks have rebounded from recent declines. UBS is buying 167-year-old Credit Suisse, which will avert a broader banking crisis, relieving the market with the strong performance of global banking stocks. Overall, there was more good news than bad news on the banking front. Most notably, the merger of Credit Suisse and UBS has certainly taken much of the pressure off the global banking system.

This means that the market's attention is now turning to the Fed. The Fed's ongoing rate hikes to curb inflation are seen as a factor in triggering market turmoil.

2. UBS to buy Credit Suisse sparked concern among Swiss political parties and public opinion.

The Social Democratic Party, the second largest party in the Swiss federal parliament, strongly condemned UBS's plan to buy Credit Suisse on the 20th. The Swiss Social Democratic Party and the Green Party also launched an initiative that day, asking the Swiss parliament to convene a special session to consider the acquisition. The Swiss Social Democratic Party leader Roger Nordmann warned that the takeover plan has "huge risks", after the merger of UBS Group's total assets will exceed 1.5 trillion U.S. dollars, too high the scale of assets will bring risks to Switzerland. In addition, the People's Party, the first major party in the Swiss federal parliament, also expressed concern that the government would bear losses of up to 9 billion Swiss francs. The party said the takeover could also have a dire impact on the Swiss job market, with the merger of the two banks likely to lead to some 10,000 layoffs.

3. Lagarde: Market turmoil will not hinder the ECB's anti-inflation battle.

European Central Bank President Christine Lagarde said Monday that turmoil in financial markets will not hinder the ECB's anti-inflation battle because it has different tools to deal with the two issues.

Some critics have said the two could come into direct conflict, forcing the ECB to make a choice, a claim Lagarde firmly refuted at a hearing Monday.

Lagarde said there is no trade-off between price stability on the one hand and financial stability on the other, and that for both kinds of stability, we are using different tools.

For inflation, interest rates will remain the ECB's main tool, while for the banking sector, the ECB can use its existing liquidity tools or design new ones. But in any case, according to Lagarde, the region's banks are resilient.

4. The Swiss government committed a total of nearly 260 billion Swiss francs in public funds to bail out Credit Suisse.

Swiss authorities announced Sunday that UBS has agreed to buy its rival Credit Suisse in a mandatory merger aimed at avoiding more market turmoil in the global banking sector. Documents outlining the deal show that Credit Suisse and UBS could benefit from more than 260 billion Swiss francs in state and central bank support, equivalent to a third of Switzerland's GDP, as part of a merger deal to weather the global financial meltdown.

The deal involves significant public funding support, including three liquidity and loan facilities, and a commitment by the Swiss government to absorb up to 9 billion Swiss francs in potential losses from the purchase.

The Swiss central bank also provided an emergency liquidity loan of up to 100 billion Swiss francs to the merged bank. The loan will be protected in the event of a default.

5. NickTimiraos: The Fed is facing a difficult decision on the issue of interest rate hikes.

Nick Timiraos, known as the "Fed's mouthpiece," writes that under the current circumstances, the Fed faces a difficult decision on whether to raise interest rates, and Fed officials must balance inflation concerns with new worries about spillover effects from the banking sector turmoil.

Nick Timiraos believes that the Fed's decision on whether to continue to raise rates by 25 bps may depend in part on how the market digests the news of UBS's purchase of Credit Suisse and whether moves taken by the U.S. and other economies to calm the market's concerns about the banking sector are working.

6. JPMorgan Chase is leading efforts to develop a new rescue plan for First Republic Bank.

JPMorgan Chase CEO Jamie Dimon is leading discussions with CEOs of other major banks about new measures to stabilize troubled First Republic Bank, according to the Wall Street Journal. The discussions, while preliminary, are focused on how the industry can increase First Republic Bank's capital, said people familiar with the matter. Sources said one of the options on the table is for two banks to invest in First Republic Bank. Sources also said a sale or outside capital injection is also being considered. Last week, 11 major banks joined forces to inject $30 billion into First Republic Bank to restore market confidence in the bank. Some sources familiar with the matter said the latest plan could involve converting some or all of the $30 billion capital into capital.

7. In the face of the industry crisis, the British government continues to consider relaxing banking rules.

British ministers will plan to further ease banking reforms introduced in the wake of the financial crisis, despite the financial turmoil that prompted an urgent takeover of Credit Suisse at the weekend, Sky News reports. The U.K. Treasury is reportedly set to issue a call for evidence in the coming days on an overhaul of the Senior Managers and Certification Regime (SMCR) to simplify the process of regulating top industry executives. According to the sources, the government will fulfill its commitment to launch the exercise by the end of the first quarter, with an announcement likely later this week. This is part of the "Edinburgh Reforms" proposed by Chancellor of the Exchequer Jeremy Hunt last year to provide a smarter, more autonomous regulatory framework for the U.K.

【Focus of the Day】

UTC+8 16:40 First deputy governor of the Riksbank Anna Breman discusses the economic situation and monetary policy work in a volatile situation

UTC+8 18:00 Eurozone ZEW Economic Sentiment Index (Mar)

UTC+8 20:30 Canada CPI annual rate (Feb)

UTC+8 20:30 Canada's monthly retail sales rate (Jan)

UTC+8 22:00 U.S. annualized home sales (Feb)

Risk Warnings and Disclaimers

You understand and acknowledge that there is a high degree of risk involved in trading. Following any strategies or investment methods may lead to potential losses. The content on the site is provided by our contributors and analysts for information purposes only. You are solely responsible for determining whether any trading assets, securities, strategy, or any other product is suitable for investing based on your own investment objectives and financial situation.

Comments

Add to Favorites

Justin

Central Bank

Economic

An extraordinary weekend in Switzerland culminated in the collapse of Credit Suisse into the wary embrace of its great rival, UBS. The latter did not want to have to buy the former. For all the Swiss authorities’ insistence that this was a takeover – a ‘commercial solution’ according to the finance minister – UBS had no choice but to make a deal work. US Federal Reserve Chair Jerome Powell and Treasury Secretary Janet Yellen gave the game away, welcoming the move by ‘Swiss authorities to support financial stability’.

For all the frantic efforts of the past few days, UBS’s leadership knew they might have to step in to shore up Swiss Finance Inc. Six months ago, a top UBS executive told OMFIF that he put the chance of a forced takeover of Credit Suisse at around 30%. At the time, Credit Suisse’s market capitalisation was around $20bn. Last night, UBS picked up a bank with assets of close to $600bn for just $3.5bn.

What lessons can be learned from this crisis? First, it’s a huge embarrassment for the Swiss authorities. Since the 2008 financial crisis, they had made the country’s two big banks carry substantially higher core capital than their global competitors in other jurisdictions, much to the chagrin of their respective leaderships. The so-called ‘Swiss finish’ could not prevent the huge withdrawal of deposits – as much as CHF10bn a day – finishing off Credit Suisse.

It also points to the dangers of a very consolidated banking system. Last week, in the highly diversified US market, where no single bank can have a market share of more than 10%, a group of the biggest and strongest US banks provided $30bn of liquidity to First Republic Bank. In Switzerland, the market solution depended on a coalition of one. The irony is that Switzerland’s banking system is even more consolidated today.

The Swiss National Bank and the Swiss Financial Market Supervisory Authority have potentially lit a fire underneath a core pillar of the post-2008 financial crisis banking capital structure. Holders of $17bn of AT1 bonds – designed for buyers to have their holdings converted into equity if a bank ran into trouble, in essence a ‘bail-in’ mechanism – will be wiped out. AT1 owners are meant to sit higher in the capital structure than shareholders, but the latter will receive that $3.5bn from UBS. Swiss authorities have prioritised giving something – albeit not very much – to the many retail shareholders and pension funds that own Credit Suisse stock. Hedge funds and other professional investors are easier to rile.

There is a precedent for AT1 bonds not being bailed in. The European Central Bank’s Single Resolution Board took the approach when it deemed Spain’s Banco Popular ‘likely to fail’ and it was consolidated into Santander. If the takeover of Credit Suisse by UBS really is a commercial decision, and given the support of the Swiss approach has been welcomed by other leading regulators, AT1s look worthless. Estimates suggest outstanding AT1s total $275bn, and their value was dropping fast on the day the Credit Suisse deal was announced.

Credit Suisse’s collapse is definitively not indicative of a global problem for the banking system. It is a unique story. Right up until its forced sale, the bank had ample capital. Until the past few days, it also had ample liquidity. Its liquidity crunch was caused by the evaporation of trust from the market. In the case of Silicon Valley Bank, for example, it was the withdrawal of liquidity that led to a collapse in confidence.

Credit Suisse’s decline was like a former champion boxer that has simply taken too much punishment. The Mozambique fines, the Archegos collapse, the Greensill scandal, multiple leaders leaving suddenly and under a cloud, financial reporting errors, misleading briefings to shareholders, strategies that didn’t pass scrutiny and perhaps the final blow landed by its own largest shareholder, the Saudi National Bank. Blow after blow. Punch-drunk. The end was inevitable.

What does this mean for UBS? It has picked up a highly profitable Swiss domestic bank which, when it was slated for listing five years ago, was valued north of $15bn. It remains a valuable asset. It gives UBS, already the world’s biggest wealth manager, an even more powerful position in a lucrative and growing business line. However, there is huge overlap between Credit Suisse and UBS’s client bases – from retail, to wealth, to Swiss multinationals – and other banks are likely to benefit from in-flows as these clients look to maintain a level of diversification.

It leaves a huge question mark about how UBS will resolve issues in Credit Suisse’s investment bank – ‘where the poison lies’, as one former executive told OMFIF over the weekend. But UBS has negotiated a loss guarantee of CHF9bn from the SNB on some of these problem assets.

Of concern to UBS’s leadership is the effect that the Credit Suisse takeover will have on its overall strategy. Its chairman, Colm Kelleher, has been on a charm offensive to persuade leading fund managers that UBS is a global, rather than Swiss, business. He had been quite successful, edging UBS’s price-to-book valuation closer to the likes of market leaders JPMorgan and Morgan Stanley. For the time being, UBS is very much a Swiss bank again.

Source:Clive Horwood

To stay updated on all economic events of today, please check out our Economic calendar

Risk Warnings and Disclaimers

Comments

Add to Favorites

Justin

Forex

Central Bank

Economic

Inflation data has been encouraging though we think the BoE will want to see more

Last month the Bank of England signalled it might finally be done with tightening, or at least that it was close. The Bank said it would monitor indicators of “inflation persistence”, which is code for being less swayed by month-to-month swings in single data points and is trying instead to get a sense of overall price-setting behaviour.

Policymakers did indicate that the burden of proof was on seeing signs that inflation was firmly easing before stopping tightening. And by and large, that is what the data has shown since the February meeting. Wage growth, according to the latest official three-month annualised figures, may finally be slowing, though it’s early days. The Bank’s own Decision Maker survey, which we know policymakers put a lot of emphasis on, has shown that firms expect to make less aggressive price increases in coming months. Perhaps most importantly, core services inflation took a nose-dive in January – though we’ll have to wait and see whether this is replicated in the most recent data due a day before the BoE decision is announced.

In short, there are encouraging signs that inflation is genuinely starting to ease. Not only are improved supply chains and lower consumer demand keeping a lid on goods price inflation, but lower gas prices should help take the pressure off the service sector, too. Until the recent turmoil in financial markets, we weren’t convinced all of this would be enough to stop the Bank from implementing one final 25bp hike, but assuming the trends continue, the committee should be eminently comfortable with pausing by the May meeting.

UK wage growth appears to be finally easing

This week's decision is on a knife edge

We’re still narrowly leaning towards a hike this week, though clearly, a lot can change in the days leading up to the meeting. One thing that’s clear from recent communications is that the bar for pausing rate hikes is much lower at the BoE than at the European Central Bank. Policymakers have been clear that most of the impact of past hikes is still to hit, which is partly a function of the low prevalence of variable rate mortgages in the UK.

On the flip side, last September/October’s UK market volatility after the ‘mini budget' saw the BoE use targeted measures to address financial stability issues. The purpose of those measures was not just to get to the root cause of the problem, but also to allow monetary policy to remain focused on tackling inflation. The result was the Bank was buying government bonds (albeit temporarily) while simultaneously promising bold interest rate hikes.

We suspect that the philosophy of at least trying to separate inflation fighting and financial stability still prevails today, and this was also a line adopted by ECB President Christine Lagarde in her most recent press conference.

In short, the meeting is on a knife edge and to a large extent it will come down to whether stability in financial markets starts to return. A calmer financial market backdrop would keep a 25bp hike on the table. Further volatility could easily see a ‘no change’ decision, with non-committal guidance that further hikes could be enacted if the situation changes.

Either way, expect the committee to remain heavily divided. We could easily have a scenario whereby external MPC member Catherine Mann votes for a 50bp hike this week, while the doves, including Silvana Tenreyro and Swati Dhingra vote for no change, or perhaps even a rate cut. As in past meetings, we expect the ‘centrist’ five to six members (including Governor Andrew Bailey) to vote largely together.

Liquidity and volatility in sterling rates is much less concerning than during the mini budget debacle

Bank of England Set for 25bp Hike Barring Further Turmoil_2

End of cycle dynamics to accelerate gilt yield drop to 3%

The pick-up in gilt volatility has not been as spectacular as that of treasuries and bunds this past week. The reason is twofold. First, the UK is perceived to be better insulated to banking troubles hitting other jurisdictions, especially the US. Secondly, markets had already integrated the BoE’s message that this cycle is nearing its end. Taken together, we think the drop in gilt yields ‘in sympathy’ with its peer is justified, although it can be expected that more stable market conditions in the coming days would also help retrace the recent drop in yields. Overall, the recent crisis reinforces our view that 10Y gilt yields are headed to 3% by late-2023/early 2024.

As in every bout of market volatility, questions are legitimately being asked about the sustainability of quantitative tightening. It is true that, as the spring budget confirmed, FY 2023-24 will result in a £200bn draw on private investors. We are confident that this extra demand will materialise but, combined with the progressive reshuffling of gilt holdings, this will likely come with periods of instability. That being said, gilts have been comparably stable in recent weeks: less volatile than treasuries and bunds, and much less than during the mini-budget debacle last year. This justifies our call for the BoE staying the course, for now.

FX: BoE not a major factor in the short term

Our base case for a 25bp rate hike by the BoE would come as a hawkish surprise given market pricing is leaning more in favour of a hold, but market conditions suggest that would not be enough by itself to trigger a GBP rally. We have seen the pound perform better than the euro during recent turbulence in the banking sector despite having a generally higher beta to risk sentiment. One way of looking at this is that investors may see the UK banking sector as less vulnerable than the eurozone. This theory could be put to the test this week as stress to AT1 bondholders after the UBS-Credit Suisse deal seems to be weighing on UK institutions’ shares.

GBP/USD remains a pure risk sentiment story: the ability of central banks and regulators to calm markets is what will determine whether the pair can test the January 1.2450 highs. EUR/GBP was largely driven by ECB-BoE policy divergence before the banking turmoil and will for now be driven by incoming news about the resilience of the respective financial systems. Once the dust settles, we think the BoE’s earlier pause compared to the ECB will ultimately favour a gradual EUR/GBP rally to the 0.9000 area.

Source:ING

To stay updated on all economic events of today, please check out our Economic calendar

Risk Warnings and Disclaimers

Comments

Add to Favorites

Samantha Luan

Stocks

The company formerly known as Royal Dutch Shell — simply Shell from January last year — has a proud European heritage. But the continent's investors don't love it, or its fellow oil companies, even while Americans rediscover the charms of petroleum stocks.

The big European oil companies, BP, Shell, TotalEnergies and Eni, trade at about five times their forward earnings; the leading Americans, ExxonMobil and Chevron, at 10 to 11 times.

All have done well with rising oil and gas prices. But while Shell's share price has gained 78 per cent since the start of 2021, ExxonMobil's is up 165 per cent.

The European corporations nearly closed the valuation gap with their US peers after the 2008-2009 global financial crisis, but it ballooned again.

The Europeans have been trying to boost their low-carbon businesses, investing in offshore wind, solar power, electric vehicle charging and batteries.

Shell and BP both recently paid billions of dollars to acquire bio-gas companies. They still have to demonstrate that they can run non-fossil businesses as well as specialist competitors do, and as well as their own petroleum assets.

The Americans, by contrast, have concentrated on their core petroleum businesses. They are developing carbon capture and storage (CCS), which fits well. Otherwise, their major purchases have been of shale oil and deepwater exploration companies. This may be short-sighted given the ever-increasing imperative of climate policy, but for now, it has paid off.

The European regulatory and public environment is not friendly to oil companies, to say the least. In May 2021, a Dutch court ruled Shell should cut its greenhouse gas emissions by 45 per cent by 2030 in line with global climate targets — including the emissions caused by customers, anywhere in the world, who burn the oil and gas they purchase.

Following Russia's invasion of Ukraine, as oil prices rose, the UK and EU both imposed windfall taxes on what they called energy companies' excess profits.

Such a levy was debated in the US but not implemented. Instead, the Joe Biden administration's Inflation Reduction Act includes subsidies (or "incentives"), both for renewables and for oil company-adjacent biofuels, hydrogen and CCS.

Last week, the White House also approved a significant new oilfield development in Alaska, despite environmentalist opposition.

In December 2021, Shell consolidated its headquarters and listing in the UK, dropping the Royal Dutch part it had held since its 1907 merger. This was primarily to make share buybacks easier and avoid the Netherlands' dividend withholding tax which had been a persistent irritant. Still, environmental groups suspected the court ruling on emissions was another motive.

That year, the company reportedly also considered shifting to the US. But it was not clear that such a move would suddenly have seen it enjoy the valuation multiples of ExxonMobil or Chevron. Some of its core shareholders would have opposed the idea, and the US levies a dividend withholding tax on foreign non-residents.

BP and Shell have shifted their focus recently. Higher oil and gas prices since the post-2014 slump, and the need to replace Russian supply, make upstream investment in hydrocarbon exploration and production more enticing.

"2022 taught us that too much focus on the decarbonisation agenda led to a mismatch between supply and demand," BP's chief economist, Michael Cohen, said last week.

In February, chief executive Bernard Looney revealed plans to cut oil and gas output to a more moderate 20 per cent to 30 per cent, from an earlier estimate of 35 per cent to 40 per cent. Within four days, BP's stock gained more than 30 per cent.

Patrick Pouyanne, TotalEnergies' chief executive, notably said in February 2021: "I'm proud to be black [oil] and green, because if I don't have the black part, which is delivering cashflows, I don't have the green part."

New Shell chief executive Wael Sawan took the top job after leading the gas and renewables business, which some took to indicate he would lead the company in a lower-carbon direction.

But before this, he ran the upstream division, and before that Shell's US upstream, and its successful global deepwater business.

As a Lebanese-Canadian who grew up in Dubai, he brings a different perspective from the previous run of Dutch, Swiss and British chiefs. Now, he is demanding that the low-carbon businesses pull their weight and earn returns commensurate with those in oil and gas.

What can the European oil companies do to counter the valuation gap with their American peers?

They could spend more on oil and gas development. As noted, Mr Looney and Mr Sawan have made partial moves in that direction. Shell and TotalEnergies have hugely promising new finds in Namibia, which could be the growth engine for them that Guyana's oil has been for ExxonMobil.

But pressure from environmentalists, the general public, the law, shareholders and even their own employees in Europe makes it impossible to go unashamedly "back to petroleum".

The European majors could go big in renewables, making a really major acquisition — more like $50-100 billion than the few billions of bolt-on deals so far — to build the scale and skills they need. But they have to accept that most low-carbon businesses are inherently lower-return — though less volatile — than upstream.

CCS will look more like sewage treatment than buccaneering frontier exploration. And today's low valuation multiples make big share-based acquisitions unfeasible.

They can be bought by the Americans — a politically controversial Transatlantic move, and likely to be impossible in the case of TotalEnergies. They could sell their upstream assets piecemeal or en bloc. BP and Shell could merge, but that would be a purely defensive move unless accompanied by a radical shake-up of strategy. Or could they find another buyer, perhaps an epochal tie-up with a Gulf company?

If they are to continue as independent entities, there is no easy way round the fundamental contradiction: European stakeholders demand energy transition but aren't willing to value it as oil company investors.

The situation won't change until the European chief executives articulate and deliver compelling pathways to high returns with low carbon.

Source: The National News

Risk Warnings and Disclaimers

Comments

Add to Favorites

Alex

Stocks

Hedge funds managers and other large investors believe it is far too soon to call an all-clear on turmoil in the global financial sector even after more than a week of financial lifelines, central bank assurances and a massive banking rescue deal.

In the past two weeks, two U.S. banks have collapsed, America's biggest lenders agreed to deposit $30 billion in another ailing firm, First Republic Bank, Credit Suisse Group AG needed a lifeline and at the end of a frenetic weekend agreed to be taken over by UBS.

Michael A. Rosen, chief investment officer of Santa Monica-based adviser Angeles Investments, said the UBS-Credit Suisse deal eliminated one potential source of instability, but fundamental problems in the banking system remained, mainly tight monetary policy.

"So maybe one hole in the wall has been plugged, but the water's rising," he said.

One hedge fund manager described trades in the financial sector as being "all over the map", with nobody agreeing on anything.

Some breathed a sigh of relief that a competitor stepped in with a rescue offer for Credit Suisse. Others worried that the $3.2 billion UBS will pay is far less than the $9.5 billion Credit Suisse was valued at on Friday, and one investor said the market may not consider this to be a positive.

Many of the roughly one dozen managers contacted on Sunday asked not to be identified because their firms prohibit them from discussing their trades with the media, or they did not want to make their views and positions public.

Others tweeted throughout the day.

Daniel Loeb, chief investment officer of U.S. hedge fund firm Third Point LLC, wrote on Sunday morning that initial news of the UBS offer for Credit Suisse would be "positive for financial system as it preserves the capital structure."

Later, short seller Jim Chanos tweeted his shock that $17 billion of Credit Suisse bonds would be wiped out, asking "What are the Swiss doing here…?!"

Chanos and Loeb did not respond to emails seeking further comment.

There was also little agreement on how investors would be positioning themselves in smaller U.S. banks, including First Republic.

First Republic's stock price tumbled 33% on Friday, one day after a handful of the country's largest banks, including JPMorgan Chase, organized a $30 billion rescue package that was supported by the Federal Reserve and U.S. Treasury.

On Sunday, credit rating agency S&P Global downgraded First Republic's ratings for the second time in less than a week, lowering its sovereign credit ratings to "B+" from "BB+". S&P maintained its outlook at "Creditwatch Negative."

"The situation is not resolving easily," said one investor who allocates wealthy clients' capital with hedge funds.

Several fund managers said it felt dangerous to bet on further declines in light of the rescue package, noting that retail investors could band together and support banks like First Republic that were seen as solid enterprises. "This name could easily go meme stock, so there is a fear of being short here," one manager said.

Investors' short interest in First Republic was at $190 million, or about 3% of its float, according to data tweeted on Friday by research firm S3 Partners, which said short-sellers had made mark-to-market profits of $537 million on the trade this year and $62 million on Friday alone.

Several investors also said they expect federal regulators to impose new rules for regional banks by tightening lending standards or forcing them to raise capital. With more regulatory pressure ahead, some said that buying stock in these banks after steep price declines might be a tougher call, because their lending activity could shrink.

Investor Ricky Sandler, who runs hedge fund Eminence Capital LP, speculated on Twitter on Friday that an investment bank might be interested in First Republic, which caters to wealthy clients.

Sandler did not respond to a request for additional comment on Sunday. A First Republic spokesman said the bank "is well positioned to manage short-term deposit activity," given last week's deposit infusion, as well as cash on hand.

The KBW Bank Index, a proxy for banks, tumbled 11.12% last week, signaling that further turmoil could lie ahead.

Some investors, including a large mutual fund group that also runs a hedge fund, said prospects for banks had gotten progressively worse in recent months given the economic outlook.

"As we thought the country would drop into recession last year, we curbed our banking exposure," said a senior executive at that group. "That feels like a good call right now."

Source: Yahoo

Risk Warnings and Disclaimers

Comments

Add to Favorites

Owen Li

Bond

Ultra-short-dated U.S. equity options should help protect investors from violent intraday price swings, but their popularity at a time of rising market instability could have the opposite effect.

So-called 'zero days to expiry' or '0DTE' options, are designed for institutional investors to hedge their exposure to outsized price swings on days of known event risk, such as U.S. employment and inflation data releases, or Federal Reserve interest rate decisions.

But they are attracting the attention of more speculative parts of the investment and trading community, at a time of increased market fragility due to higher interest rates, an unfolding banking crisis, and growing fears of wider economic and financial turmoil.

In a report published earlier this month, analysts at JP Morgan sketched out a worst-case scenario in which these options could trigger an intraday 25% rout in the S&P 500 if they are unwound following an initial, sudden 5% market drop.

Understandably, a potential 25% crash in one day garnered a lot of attention. But even the less gloomy hypotheticals outlined in the report, such as a sudden 1% or 2% slump, still pointed to an even greater selloff than the original fall.

Peng Cheng, one of the authors, says this kind of scenario is less likely to play out on 'event days' like nonfarm payrolls data or Fed policy decisions. Investors know the event risk so they tighten controls, and are generally more cautious.

All else equal, this helps reduce systemic risk to the wider market. But on 'non-event days,' speculative activity increases.

"These options are being used more now for systematic trading, which is surprising ... (and) because of that, they have more potential to increase volatility on 'non-event days,'" Cheng said.

"On 'non-event days' there is more chance of an unexpected market shock, in which case investors may face greater losses in their short option positions, and that may increase intraday volatility," he added.

This nods to the Rumsfeldian world of 'known unknowns' and 'unknown unknowns.' Calendar event risk, or 'known unknowns,' may unleash market volatility, but investors can hedge or sit on the sidelines. Their '0DTE' options positions are much more likely to be hit by 'unknown unknowns' at random times.

Popularity Surges

Data from Cboe Global Markets shows that '0DTE' options have grown in stature over the past several months. They have accounted for more than 40% of daily turnover in all S&P 500 index options since last July - a year ago it was around 20%.

'0DTE' Options Trading Could Exacerbate Stock Market Volatility_1

Nominal trading volumes in these contracts often spikes up on 'event days' like U.S. jobs and inflation data days. The 1.7 million contracts traded on March 10, the day of the February employment report, is second only to the 1.76 million traded on Oct. 13, the day September CPI inflation data was released.

However, as a share of overall options turnover - which Cheng says is a better indication of potential market risk - many of the recent peaks have been on random 'non-event' days.

'0DTE' Options Trading Could Exacerbate Stock Market Volatility_2

He and his colleagues estimate that the daily notional value of trading in '0DTE' options has grown to about $1 trillion. Reuters exclusively reported last week that Wall Street players and a major U.S. clearing house are examining the potential risks the explosion in trading these contracts poses.

But the Cboe points out that volume is evenly split between 'put' and 'call' options, reflecting a balanced market. Some 65%-70% of trades are closed out before expiry, which caps the accumulation of large, outsized positions, the exchange adds.

But it is worth monitoring how these options evolve, particularly with the Fed switching to a more data-dependent policy stance, which could in turn generate more speculative activity on big calendar 'event days.'

Fed Chair Jerome Powell indicated to lawmakers earlier this month that the decision to raise rates by 25 or 50 basis points at the March 21-22 policy meeting would likely hinge on February employment and CPI inflation data. These reports were released on March 10 and 14.

It's one thing for central banks to be 'data-dependent,' another to pin policy decisions on specific data.

"My sense is that Powell was trying not to surprise the market with 50bp — a little bit of forward guidance," said John Silvia, economist and founder of Dynamic Economic Strategy. "But it is very rare — and risky – to make such a specific number outlook."

Source: Reuters

Risk Warnings and Disclaimers

Comments

Add to Favorites

Samantha Luan

Forex

USD: UBS-CS deal no boost for sentiment

The weekend brought two very important developments for global markets. The acquisition of Credit Suisse by UBS, orchestrated by Suisse authorities, was announced. While this surely offers a breather to global markets as a black swan scenario is ruled out, it came at a rather hefty cost for some categories of investors, which is ultimately showing its negative impact on markets this morning. The acquisition price was CHF 0.76 a share, well below CS's CHF 1.86 closing price on Friday, and around CHF 16bn worth of CS Additional Tier 1 capital bonds are being wiped out. Other lenders' AT1 bonds are coming under pressure this morning, bringing respective shares lower, on fear of contagion. In other words, black swan risks may be lower, but financial turmoil is not over.

This is one of the reasons why the Federal Reserve and five other central banks announced a coordinated action yesterday to provide extra liquidity to money markets by increasing the frequency of its USD swap lines operations from weekly to daily. As noted by our rates colleagues here, this appears to be a purely precautionary measure by the Fed, considering that there was no material evidence of outsized demand for dollars last week. There is currently $470bn being drawn through swap lines, which is modestly higher than $390bn a month ago, but nothing compared to the $5tn seen at the peak of the pandemic shock.

One could speculate this is a step by the Fed to separate price stability and financial stability, having a secondary goal to go ahead with a 25bp rate hike this week. As discussed in our preview, a quarter percent move remains our base-case scenario, even though volatility in the US and global financial sector make it a very close call. The Fed funds futures curve is pricing in only a 50% probability of a hike this week, raising the chances of a positive dollar reaction in our base-line scenario.

More broadly, we suspect that despite some respite in markets from the UBS-Credit Suisse news this morning, lingering stress in the financial sector and defensive positioning ahead of the FOMC event risk should offer support to the dollar. We could, ultimately, see a 25bp move as a sign of confidence in the market's solidity and along with some gradual easing in global banking turmoil, dollar losses might start to emerge towards the back of the week. In the rest of the G10, we continue to see the yen stay in demand for now.

Still, we have learned how news can change market conditions very rapidly in the current environment, so caution around clear directional views remain warranted.

EUR: More pressure into the FOMC possible

EUR/USD is trading in the 1.0650/1.0700 range this morning after absorbing the Credit Suisse acquisition news, as markets clearly remain very cautious about the health of the European banking sector. In line with our dollar view discussed above, we think the pair may face more pressure into the FOMC meeting but may find more strength in the second half of the week.

Incidentally, we'll see preliminary PMI readings for March on Friday, which have recently painted a rather encouraging picture for eurozone growth prospects and may endorse the recent decision by the European Central Bank to keep tightening despite financial turmoil.

There are three other G10 central bank meetings this week in Europe: the Bank of England (more in the GBP section below), the Swiss National Bank and Norges Bank. The SNB meeting appears very ill-timed: the recent rise in inflation, aggressive tightening by the ECB and the low frequency of SNB rate announcements (once a quarter) would all point to a 50bp hike, but the recent turbulence in the Swiss banking sector may argue against such a large move. Our economics team's call is still for a 50bp hike, but it's a very close call. Elsewhere, Norges Bank should hike by 25bp as previously announced, but the recent developments will likely reduce the willingness to sound hawkish on the future path of rate hikes.

GBP: Pound resilience in doubt

UK stock futures point to a weaker opening than other European markets as markets see some contagion risks for AT1 bondholders at some UK institutions. Still, the pound seems to be holding up surprisingly better than other G10 peers this morning. We had previously deemed GBP resilience versus the euro during the banking turmoil as markets seeing the UK banking sector as not as vulnerable as the eurozone one. Given GBP is generally more sensitive to risk sentiment than the euro, and the UK banking sector is coming under scrutiny this morning, we see risks of a EUR/GBP rebound back above 0.8800 today.

On Thursday, the Bank of England will announce monetary policy and while we expect a 25bp rate hike, it's closer to a 50/50 call, as it is for other central banks meeting in the current highly volatile environment. Market implied probability of a hike is 57% at the time of writing, although a big GBP rally may be prevented by policymakers strongly signalling a pause.

CEE: Following the global story

It is hard to see the CEE region taking the initiative and we expect the global story to be closely followed this week as well. Today, we will see industrial, labour market and PPI data in Poland. We expect another weak number for industry while still remaining in positive territory as PMI indicators have indicated for some time. Tomorrow, retail sales in Poland may be slightly weaker for February. Then on Thursday, we will see unemployment data in Poland which could show a one-tenth increase to 5.6%. We expect the Hungarian unemployment rate to come in at 4.1%. In the Czech Republic, Friday will also see the release of consumer confidence for March, which has seen a strong recovery since the start of the year.

We also have two interesting sovereign rating reviews in Romania and Poland on Friday. Fitch has held a negative outlook on Romania BBB- since April 2020 and we see more than a 50% chance that we could see a return to a stable outlook. Moody's holds a stable outlook on Poland A2 and we do not expect any changes this time. However, it will be interesting to follow the agency's view on recent developments in the government's relations with the European Commission, access to EU money and the FX mortgage saga.

In the FX space, global market sentiment will be key for the CEE region, led by the Fed decision and EUR/USD levels. However, as mentioned earlier, we remain positive on the CEE region, which should see a decent recovery if the global story calms down. Our favourites remain the Czech koruna and Hungarian forint, which lost most of their position last week. Both are also benefiting from record-low enegy prices and hawkish central banks keeping a close eye on FX levels. However, Monday's opening indicates that the market will be looking for safe ground for a while yet and we may see more weakness in CEE in the meantime. However, unless the Fed surprises with a 50bp hike, higher EUR/USD levels and improved sentiment should be positive for the region. The key level for the Czech koruna remains 24.10 EUR/CZK and for the Hungarian forint 402 EUR/HUF, which should limit losses. The Polish zloty confirms decent resilience to global turbulence and should hold below 4.72 EUR/PLN.