Insights / March 2023

A banking story.

Those with a crystal ball will tell you that it was evident that Silicon Valley Bank (SVB) would go bust, that all the clues were clearly printed in the footnotes of the financial statements. While risk management clearly failed in this case, it should be clear that ANY bank in the world facing a run, no matter how well capitalized, would experience the same demise. Similarly, Credit Suisse had to be saved due to a lack of liquidity it faced from a loss of trust culminating after years of mismanagement. However, this is not the financial crisis v.2.0. The issues facing the banking industry stem from very isolated cases which are being handled by their respective governments.

Nevertheless, these events created a volatile environment, which has since greatly subsided. This likely resulted in a slowdown in the momentum of rate hikes in the short-term, but no incidence on the central banks’ terminal rate, which will largely depend on inflation figures.

In the US, after the storm, markets picked up, closing strongly in positive territory, erasing the February losses. The US job market is still strong and remains the main driver of growth, but if it is any indication of what is to come, management calls with investors mentioned, for the first time in a while, more often the terms “job cuts” than “labor shortage”.

Banks are seeing large outflows of cash from current accounts for two main reasons. First, the fear around bank deposits pushing investors to limit cash on account. Second, clients are noticing that their banks are really slow to increase the interest rate they offer and that they can easily earn 4%-5% being invested in money market funds or treasuries instead. Some of that cash is also going into bonds and equities which has amplified the performance observed this month.

In Europe, the March inflation reading was strongly down from 8.5% to 6.9%. This is to be taken with a grain of salt however, as the reason comes from the base effect in energy prices following last year’s invasion of Ukraine by Russia. If you take energy out, core inflation is marginally up, likely causing the European Central Bank to remain vigilant. Incidentally, the catch-up game of the BCE with the FED in terms of rates is a driving reason for USD weakness versus EUR.

China is seeing a vigorous pick up in the construction and services sectors, in no small part thanks to an accommodating central bank. Many Asian countries stand to benefit from the reopening of China, like Japan, who’s biggest export market is China, the tourism industry, and any sectors exposed at some level to the Chinese goods supply chain. Our fears remain geopolitical, given the continuing tension between China and Taiwan/US.

Our summary recommendations

We continue to preach keeping a minimum of cash on account, and this precaution has proven to be the right choice in the context of what happened in the banking sector this month. Favor T-bills, high quality short maturity bonds and money market funds for short term liquidity instead of cash or term deposits not only to avoid bank specific risk, but also because it yields more. Furthermore, we recommend avoiding riskier fixed income securities such as high yield and emerging markets.

We have witnessed short but intense volatility events which created windows of opportunities to structure low strike products at interesting coupons.

Also, as we see the correlation between treasuries and equities going up, we would recommend choosing decorrelated investments in alternatives such as trade finance and long/short bond funds.

Chart of the month

The below graph shows the clear shift we explained further up from bank deposits to money market solutions. As banks start increasing deposit rates and as the sector regains clients’ trust, we should see this trend stabilize and reverse to some extent.

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