Information correct as of 13 April 2023. Events in the banking sector disrupted markets over quarter one of 2023. For April’s Skipton Insight, we take a look at what March’s unrest could mean for the economy, the market outlook, and investors.
In a nutshell
- Towards the end of March, a handful of banks experienced a unique set of funding concerns. It’s caused nervousness around the globe and volatility in markets.
- As a result, bond prices have risen as markets expect central banks like the US Federal Reserve to ease up on tightening interest rates.
- The events that unfolded appear to be isolated, rather than the start of a wider banking crisis. Though there is a chance that banks become stricter when it comes to lending, which may cause a slowdown in the economy.
- All in all, global markets ended quarter one in positive territory. As always, it’s about keeping a long-term mindset during bouts of short-term market volatility.
A rocky few weeks
The end of March was an unsettling period for investors. The threat of a possible systematic banking crisis created significant volatility pretty much across the board.
When interest rates rise as rapidly as they have done, strains are likely to show up somewhere in the financial system. The victims this time around were three US regional banks and the forced takeover of Swiss banking giant Credit Suisse.
What went wrong?
The biggest of the US banks to collapse was California’s Silicon Valley Bank. It was forced to sell its holdings in long-dated US government bonds to meet the demands of cash withdrawals from its clients.
By selling the bonds at a lesser price than they were bought for, the bank had little choice but to accept a considerable loss.
It led to a vicious cycle. More and more nervous deposit holders wanted to withdraw their cash. Fears over the bank’s health continued mounting. The bank had to accept more losses.
It ultimately led to the bank’s collapse. The US Federal Reserve and regulators had to step in to help cover depositor’s money.
Next up, it was Credit Suisse’s turn. Unfortunately for Credit Suisse, it hadn’t gained the greatest reputation in recent years. Following several big losses, scandals and poor profitability, the bank was seen as one of the weakest links in the global banking system.
Investors sold shares and bonds quickly as customers pulled money out in their droves. Switzerland’s central bank regulators stepped in and forced Credit Suisse’s rival UBS to take it over.
A balancing act for the US Federal Reserve
Bond markets currently reflect expectations that the unrest will force a change in interest rate policy from the US Federal Reserve (Fed) and other central banks. Prices have risen, which is a positive for any bonds you hold in your portfolio. Government bonds are typically worth more when interest rates are low or expected to fall.
On 22 March, the Fed made the decision to raise interest rates by 0.25%. It reflected a need to continue tackling high inflation but also maintain financial stability. The increase was lower than 0.5% markets had expected at the start of the March. Even so, it was still a hike.
Fed Chair, Jerome Powell, made it clear the central bank had scaled back its tightening plans as a result of events in the banking sector. At the same time, he noted that US inflation data remains too high, along with a tight labour market.
It was a difficult situation for the Fed to be in. If it decided not to hike rates at all, it may have sparked fears that the situation was worse than markets thought. This might have led to further deposit withdrawals and selloffs across the banking sector and markets in general.
Had they gone ahead with a 0.5% rise, there was a risk of overdoing it and being blamed for aggravating the situation. Instead, the Fed chose to take the middle ground with a smaller rise than anticipated.
The recent turmoil in the banking sector could be a sign that tighter policy is finally starting to bite. Going forwards, markets expect the Fed to ease rate hikes sooner than planned.
It’s actually hard to tell markets experienced such high-profile bank failures only a few weeks ago. At the time of writing, the global equity benchmark is more or less unchanged compared with the end of February and the end of December.
There are reasons to believe it’s unlikely what played out at the end of March is the start of a systematic banking crisis. Each of the banks that experienced problems over the quarter were very specific to those banks. The issues related to their own challenges and business models.
The speedy and decisive response from policymakers supports a more optimistic outcome. Many economists believe that the global banking system remains well capitalised and central banks have a range of tools to offer support. The already quick response so far shows a ‘whatever it takes’ approach to staving off a financial crisis.
But there’s a good chance that lending conditions become even tougher. The natural response from banks is that they do all they can to appear conservative and reliable. This means lenders are likely to turn more cautious.
There were signs of this last year. Banks had already started tightening their lending standards, so there’s a possibility this will only intensify.
There are still mixed views whether a recession is on the cards. If central banks continue to tighten and commercial banks become stricter with lending, it becomes tougher for households and businesses to borrow. There’s a chance this could negatively affect economic growth and lead to a mild global recession.
What does it mean for you as an investor?
Despite all that took place, the first three months of the year probably went better than you think they did. Although it was a topsy turvy quarter, the numbers in general look good.
For example, the S&P 500 ended the quarter 7% higher than it began the year. The tech-heavy Nasdaq was up 17%. Even the FTSE 100 – which has a lot of exposure to financial sector companies – managed to deliver a small return.
When there are a lot of negative headlines, it’s all too easy to focus on what’s happening now and forget about the long-term. We believe investors should balance the short-term noise with their long-term focus.
And as we always like to remind you…
The failure of a few individual banks and the shakeout in banking shares is a good reminder of why it’s so important to have a diversified portfolio. As a Skipton customer, you have a low amount of exposure to the banks involved.