Global Economy & Markets, Weekly Roundup 15/03/23

Investors turn attention to ECB amid the current choppy financial environment 
Key Takeaways
The European Central Bank, due on Thursday, is expected to stay the course, increasing interest rates by +50 basis points. Economic projections are likely to move higher for 2023 real GDP growth to +1% from +0.5% in December 2022 ECB estimates, on the back of a more resilient-than-expected economy and significantly lower energy prices (current 2023-2025 average TTF natural gas future prices of €47/Mwh versus €97/Mwh in December 2022 ECB estimates). 

Core inflation forecasts are also likely to shift higher in 2023 (to +4.6% from +4.2% in December 2022 ECB estimates) due to the resilient economy, as well as due to the re-acceleration in core prices in the past two months, offsetting lower energy prices and resulting in broadly unchanged headline inflation estimates (to +6.5%). The ECB is expected to remain data-dependent, probably providing measured, instead of hawkish, guidance vis-à-vis the interest rate path.

The respective pricing in financial markets, both for euro and USD interest rates, has exhibited large swings due to the collapse of Silicon Valley Bank, the 16th largest bank in the US by asset size ($210 billion or 0.9% of total US bank system assets). 

As the effect of noise trading diminishes, market pricing (according to overnight index swaps) now points to roughly additional hikes of +100 bps for euro policy interest rates and +25 bps for USD policy interest rates in the course of 2023, from +140 bps and +70 bps, respectively, ten days ago.

To stabilize the US banking system, the US Treasury, the Federal Reserve, and the Federal Deposit Insurance Corporation (FDIC) intervened swiftly and announced two key policy measures. First, they used the systemic risk exception to cover all deposits in both banks, including those not being covered by deposit insurance (up to 250k per depositor), with the cost being funded by the FDIC’s Deposit Insurance Fund (DIF), which had a balance of $125 billion as of Q4:2022.   

Moreover, the Fed announced the Bank Term Funding Program (BTFP), to provide loans of up to one year to eligible depository institutions that pledge assets as a collateral, with the Fed value these assets at par, instead of the standard procedure that assets are valued at fair value with a margin being applied to account for assets’ historical volatility (e.g. margin for Government Securities and agency MBSs: 100%, for A to AAA rated Non-Financials’ USD Corporate Bonds in USD: 92% to 98% depending on duration). 

The facility is backstopped with $25 billion from the Treasury’s Exchange Stabilization Fund, which had a total net position of $38 billion as January 31st, albeit the Fed does not expect that it will be necessary to draw on these backstopped funds. 

Overall, elevated risk aversion sent bank stock prices and headline indices significantly lower across the board following the SVB failure. The S&P500 recorded cumulative losses of -4.7% (March 3rd to March 13th), finishing Tuesday 14th modestly higher by +1.6%. The S&P500 Bank index declined by -18% in the same period (March 3rd to March 13th), edging also slightly higher on Tuesday. In the current environment, equity and bond volatility, is expected to continue, with European banks falling steeply into the red on Wednesday’s early trading.
Global Economy & Markets, Weekly Roundup 15/03/23