Global Economy & Markets, Weekly Roundup 28/03/23

Volatility will continue as global markets digest the stress in the banking sector (Silicon Valley Bank, Credit Suisse) and its economic implications
Key Takeaways
As investors digest recent pockets of stress in the banking sector and continued monetary policy tightening, equity market conditions remain excessively volatile. So far this month, the S&P500 has been broadly flat and the Eurostoxx50 has declined by -1.5%, with pressure on bank stocks (see graph page 3). On the other hand, Technology and defensive sectors have overperformed. 

The MOVE index, which measures bond market volatility, hit the 200s, as markets have increasingly started to price in interest rate cuts over the next one to two years, particularly in the US. So far this month, US Treasury yields have declined with the curve bull-steepening (see graph below). On the other side of the Atlantic, government bond yields have decreased across the board, with euro area periphery bond spreads broadly unperturbed.
High-yield corporate bond spreads have widened by circa 90 basis points month-to-date, due to increased risk aversion rose, as well as due to repercussions of the 100% write-down of the nominal value of all AT1 shares of Credit Suisse (see graph page 3).

The Federal Reserve increased interest rates by +25 bps to a range of 4.75% - 5.0%, with officials examining the option to remain on hold given recent concerns about the US banking sector, the cumulative tightening of 450 basis points in the past twelve months and bank stress leading to tighter lending standards and slower lending growth.  
Regarding macroeconomic projection, the Federal Reserve incorporated a high likelihood of the recent pockets of stress in the banking sector resulting in a tightening of credit conditions, in turn leading to downside effects on economic activity, employment, inflation and a more cautious path for the Federal funds rate (see Economics). The median of FOMC participants’ assumptions points to FFR of 5.1% by end-2023 (unchanged compared with projections three months ago), suggesting one more hike of 25 bps following the one undertaken in the latest meeting. 

On a positive development, borrowing at the Fed’s liquidity facilities was broadly stable in the week ending March 22nd suggesting that liquidity needs have not deteriorated further. The Fed has lent $110 billion ($153 billion on March 15th) in the primary lending program, where the Fed values securities collateral at fair value, with a variable cost broadly based on FFR. The decline was offset by increased borrowing at the newly announced Bank Term Funding Program ($54 billion from $12 billion on March 15th), where the Fed values securities collateral at nominal value, with a variable cost of 1-Year USD OIS plus 10 basis points, currently at 4.78%. 

Overall, Fed has circa $354 billion in loans outstanding to depository institutions or 2% of total domestic deposits (see graph below) including $180 billion in the FDIC-operated “bridge banks”.

The FDIC, on Sunday, entered into a purchase agreement with the First-Citizens Bank (“FCB”), for the latter to acquire all deposits and $72 billion of loans at a discount of $16.5 billion from the former Silicon Valley Bank (“SVB”). The bridge entity that the FDIC had established to facilitate the handling of the failed SVB, had $119 billion in deposits and total assets of $167 billion. The FDIC estimates the cost of the failure of Silicon Valley Bank to its Deposit Insurance Fund (with a balance of $128 billion) to be approximately $20 billion.
Global Economy & Markets, Weekly Roundup 28/03/23