This Time is Different

Equity markets last week lost 3.6% in local currency terms and 4.4% in sterling terms, more than reversing their gain of 1.8% the previous week. A hawkish Fed and an unexpected collapse of a US bank were the main reasons for the drop. As for bond yields, despite a spike higher mid-week, they ended down 0.25% or so.

The US was even more the focus than normal, with Fed Chair Powell’s Congressional testimony the first event to grab the market’s attention. In contrast to his rather dovish remarks after the last Fed meeting in February, this time he was unashamedly hawkish.

Powell stated that the peak level of interest rates is likely to be higher than previously anticipated as a result of the recent stronger than expected economic numbers. More specifically, he said the Fed would be prepared to increase the pace of rate increases once again if warranted by the data. This seemed to leave the question of whether we see a 0.25% or 0.5% hike on 22 March resting on the February employment and inflation numbers.

The first of these releases was on Friday and was a mixed affair. Employment once again posted a larger than expected gain of 311k, albeit well below the blow-out 504k increase in January. But the unemployment rate unexpectedly rose to 3.6% from 3.4% and wages increased less than forecast to be up 4.6% on a year earlier.

The second factor behind last week’s sell-off came out of the blue. SVB, a smallish US Bank, ran into problems and was promptly put into receivership by the regulators. This triggered memories of the Global Financial Crisis, when problems at the investment bank Bear Stearns proved to be the canary in the coal mine, and triggered a wider sell-off in the banking sector.

This time it really should be different, even if these are the most dangerous words to utter in finance. The clue here is in the name. Silicon Valley Bank was very much focused on tech start-ups and ran into problems as the rise in interest rates had led to deposit withdrawals and was forcing it to sell its government bond holdings at a loss.

The problems SVB faced are not applicable to the large banks which do not face a run on their deposits and generally benefit, rather than suffer, from higher interest rates. If there were a deep recession, they would face a tough time but there is no sign of this at the moment and crucially they are much better capitalised than back in the financial crisis.

By close Friday, the market was back to pricing in US rates peaking at 5.25-5.5%, 0.75% up on the current level, rather than the 5.5-5.75% it had been fearing mid-week. With markets in skittish mood, the Fed looks rather less likely to step up the pace of rate increases again, assuming no nasty surprise in this week’s inflation numbers.

Here in the UK, the only real market-related news was that the economy continues to hold up better than expected. GDP rose a larger than anticipated 0.3% in January, reversing a good part of the decline in December and leaving activity unchanged over the last three months.

Wednesday’s Budget is unlikely to contain anything to change this picture of a stagnating economy. The Chancellor has a £30bn windfall as a result of public borrowing coming in lower than expected this year. But, other than a probable extension of the support on household energy bills, any give-aways look set to be limited.

This coming week, the market’s eyes will be firmly focused on the US inflation data on Tuesday rather than the Chancellor’s red box on Wednesday.

Rupert Thompson – Chief Economist