The banking crisis – triggered by the collapse of Silicon Valley Bank (SVB) following disastrous balance sheet management, and the fall of Credit Suisse which has been taken over by its rival UBS – has sent shockwaves through the financial sector and cyclical stocks more generally since the beginning of the month.
Investors fear a sharp deterioration in the economic outlook, which would inevitably weigh on corporate profits, particularly in the most economically sensitive sectors. The sharp fall in commodity prices – the price of oil has lost more than 10% since the crisis began – also illustrates these fears of recession.
Will monetary policy change?
The banking crisis has also created turmoil on the bond and money markets. Expectations regarding the trajectory of the Federal Reserve's key interest rates (raised by 0.25% on 22 March) have been revised downwards significantly. The markets are now expecting the Fed Funds Rate to peak at a level slightly below 5% (compared to 5.5% before SVB’s collapse), with the first cut at the beginning of the second half of the year. Long-term interest rates are also declining sharply: US 10-year and 30-year yields are 40 to 50 basis points off their recent highs.
Fears for the economy
This downward trend across the yield curve may look exaggerated but it also reflects fears that the banking shocks will have a negative impact on the economy. Lending conditions – and financial conditions more generally – could tighten significantly, further weakening an already fragile economic dynamic. This complicates the central banks’ task since inflation is still not under control.
Inflation, a priority in the eurozone
Core inflation (which excludes energy, food, alcohol and tobacco) continued to accelerate in the eurozone last month (5.6% year-on-year in February). Against this backdrop, the ECB raised its main policy rates by 0.5%, taking the refinancing rate to 3.5%, its highest level since 2008. However, the European monetary authorities would not commit to future policy moves in order to give themselves time to assess the risks weighing on the European financial system and the evolution of macroeconomic data.
Central banks to the rescue of the financial system
In this turbulent environment, the central banks reacted promptly to avoid a contagion phenomenon similar to that seen in the 2008 financial crisis. They were quick to provide the necessary liquidity to institutions weakened by an outflow of deposits in order to preserve and stabilise the banking system as a whole. The massive use of these emergency support measures emphasises the authorities' pragmatic attitude.
Focus on a cautious approach and quality assets
The sharp rise in risk aversion and heightened fears looming over the economic cycle call for a cautious approach. We believe it is more vital than ever to focus exclusively on quality assets. The quality style has made a strong comeback, outperforming the value style since the beginning of the year, thereby erasing part of its lag in 2022.
Damien Petit, Head of Private Banking, Banque de Luxembourg