Global Market Quick Take: Europe – March 20, 2023

What is our trading focus?

US equities (US500.I and USNAS100.I): still a focus on regional banks

Today’s focus is on European banks given the takeover design of Credit Suisse creating steep losses for the additional tier 1 holders sending potentially shockwaves through an important funding market for banks. S&P 500 futures are down 1%, so a little bit more relaxed than European equity futures, but the US banking system is not without stress and news over the weekend indicates that Warren Buffett is in talks with the US government to do some kind deal on US regional banks. This part of the banking system is the most vulnerable to declining deposits in the system as those are the most important funding source.

European equities (EU50.I): Credit Suisse takeover is next litmus test

If the Credit Suisse takeover by UBS, orchestrated by the Swiss government, was expected to calm the market, then today’s trading session will be an important litmus test of this thesis. STOXX 50 futures are down 1.6% as the market is interpreting the Credit Suisse takeover design as bad with all the additional tier 1 capital holders being written down to zero taking the full loss together with shareholders. Key indicators to watch today are still Bitcoin and gold as proxies for the public’s distrust in the global deposit system which is a key funding source for banks.

Hang Seng Index plummeted 3.4%, driven by financials

Banking and insurance stocks were weighed by the news that more than USD17 billion in Credit Suisse’ additional tier-1 bonds or also known as CoCo bonds being wiped out in the takeover of the second largest bank in Switzerland by UBS in a deal brokered by the Swiss regulators. HSBC (00005:xhkg) plunged over 7%. Prudential Insurance (02378:xhkg) dropped 9.3%. CSI300 rallied in early trading driven by electronics, electric equipment, non-ferrous metal, and construction material names before paring gains to edge down around 0.5%.

FX: risk-off into European morning after initially hopeful reaction

The USD and JPY opened lower in the wake of the announcement of the SNB takeover of Credit Suisse bank but spreading unease on the implications of the deal saw the USD finding support, but the JPY is the real performer on the strong side yields are getting pummelled back lower and safe haven like gold pulls higher into early European trading. USDJPY traded as high as 132.50+ early in the Asian session but is pounding down well below 131.00 as of this writing in early Europe. Given the elimination of Credit Suisse’s AT1 corporate bonds and the heavy usage of the AT1 bond model for European and UK banks, this space deserves focus as a risk into the euro and sterling if contagion risk is seen.

Crude oil struggles as bank rescue fails to lift sentiment

Crude oil prices fell sharply last week as the fears of a banking crisis weighed heavily on sentiment as it raises growth and demand concerns. Overnight a small bounce was soon reversed after the weekend rescue of Credit Suisse failed to convince the market that it will remove let alone reduce the current liquidity crisis. Most of the sell-off last week was driven technical selling –as seen through rising open interest hitting a one year high - and long liquidation from funds, and until that changes short sellers will remain in control. Focus in the week ahead apart from the banking crisis will be central bank decisions from the FOMC, PBoC, BOE and SNB. WTI will be looking for support around $62 while in Brent a break below support at $71 could see it target $65 next.  

Gold trades breaks above 2000 as safe havens remain in demand

Gold trades back above $2000 an important phycological level, as investors continued to seek safety in heaven assets amid a banking crisis that has not eased despite UBS taking over Credit Suisse and central banks stepping in with fresh liquidity measures.  Gold and silver ended up 6.5% and 10% last week, and together with Bitcoin they are currently being seen as safe havens and a gauge for the underlying market risk sentiment. Heading into the latest crisis, precious metals were dramatically under owned by traders and investors who had been heavy sellers during the February correction. ETF holdings in gold jumped the most in a year last week but at 2871 tons it remains almost 450 tons below the 2022 peak while speculators in futures cut their net long positions by 78% during a five-week period to March 7. Focus on the banking sector response to the CS bailout as well as the FOMC meeting on Wednesday where the outcome is going to be the most difficult to predict in years.

Treasury yields plunge on accelerating expectations for CB easing

US treasury yields rose slightly at the Asian open on hopes that the UBS takeover of Credit Suisse would bring some relief to broader risk sentiment, but this move was quickly erased and instead US yields plunged to new lows at the front of the curve that haven’t been seen since last September, as the US 2-year benchmark hit below 3.7% as the market has now almost removed all further tightening expectations from the Fed forward curve. The 10-year posted a new low for this year below 3.35% and the 2-10 yield slope inversion has steepened to a mere –35 bps after worse than –100 bps less than two weeks ago.

What is going on?

Fed and global banks move to boost US dollar funding

In a coordinated effort, the Federal Reserve and five other central banks, changed their US dollar swap arrangements, in a bid to create more liquidity to ease growing strains in the global financial system. The Fed, along with the Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank and the Swiss National Bank on Sunday banks changed their 7-day dollar swap maturity operations, from weekly to daily. This simply means their settlement will move from weekly to daily, to ensure there is more flowing capital in the system. The operational change will begin on Monday March 20 and continue until at least the end of April.

The Fed has made changes like this in the past when the availability of US dollars shrinks. And it has of late, with some global banks rushing to shore up liquidity, and thus borrow cash from the Fed, as some banks were worried deposits would dwindle. Lenders borrowed $165 billion. Also consider, separately, that emergency lending by the Fed, reversed several months’ worth of Fed efforts to shrink its balance sheet.

Bank stress on watch despite authorities’ quick fixes on Credit Suisse

Risk on returned to markets at the Asia open on Monday, with reports of a takeover of Credit Suisse by UBS and improvements to dollar funding liquidity. But while authorities have stepped in to prevent a systemic event, the fixes appear to be a short-term cure. We continue to watch the credit markets in the week ahead for any signs of further stress, specifically from the Credit Suisse AT1 bonds that have been written off. This may pose a legal challenge given that equity value in Credit Suisse was made good, but it also means that values of AT1 bonds of other banks could take a hit. Additional Tier1 (AT1) bonds, part of the Contingent Convertibles or ‘Cocos’ family, are hybrid bonds or callable securities which offer higher yields than more senior debt and can be converted from bonds into equity (or written down entirely) in the case of a credit event. The fact that CS’ Cocos were not converted to equity but written down could mean a broader re-rating and repricing in the corporate bond markets. Also, on watch this week will be the credit default swaps for key US and European banks, any changes to their credit ratings and the financial conditions that are once again approaching to be the tightest in the cycle.

The PBOC’s 25bp cut to the RRR; all eyes on today’s loan prime rate fixings

The People’s Bank of China (PBOC) announced on Friday, after the market close, that the central bank is cutting the reserve requirement ratio (RRR) by 25 basis points for all banks that are currently subject to a RRR above 5%, bringing the weighted average of RRR across banks to 7.6%. The move is estimated to release between RMB500 and RMB550 billion in loanable funds into the banking system. The 25bp cut in RRR is relatively modest as the norm before 2022 was 50bps to 100bps and as large as 300bps in April 2019. Nonetheless, it is in line with the more moderate moves in 2022.

What are we watching next?

Contagion risk from SNB takeover of Credit Suisse at the weekend.

As noted in Steen Jakobsen’s Macro Digest, the risk from the UBS takeover of Credit Suisse stems from the wipeout of Credit Suisse’s $17 billion of AT1 bonds if this stokes a wider assessment of the credit quality of similar bonds issued by other banks, particularly European and UK banks that have issued debt of a similar type. Last week, a WisdomTree Tier 1 CoCo ETF that tracks bonds of this type dropped about 10%. The general knock-on effects into risk sentiment as broader, systemic concerns come into play is a risk if the UBS takeover move is positioned as a non-solution that fails to put a lid on the situation.

Macron’s government faces a moment of truth today

On Friday, French opposition lawmakers filed two motions of no-confidence after the government bypassed parliament the day before to push through the unpopular pension reform (the main measure aims to raise the pension age by two years to 64). The vote is scheduled for today. There will be no majority to bring down the government. However, this will certainly accentuate pressure on President Macron. At the same time, violent demonstrations are happening almost every day in Paris. Why are the French angry? In our view, the current state of the political debate is mostly due to people’s fear of not being able to sustain a full career by age 62-67 (actually most French retire after 62 to get full pension), worried about their standard of living once retired and many finding Macron insufferable.

Geopolitics back in the focus this week

The Chinese Foreign Ministry has confirmed in a statement on its website that President Xi Jinping's much anticipated state visit to Russia will be held from March 20-22, marking the first such in-person visit with President Putin since the Ukraine war started in February 2022. It is being reported that the two leaders will discuss strategic cooperation, whereas the world will be watching if President Xi tries to mediate on the invasion of Ukraine. Meanwhile, the International Criminal Court (ICC) issued an arrest warrant for Russian President Putin, alleging forcible deportation of Ukrainian children is a war crime. The reaction to this accusation remains on watch and could create another geopolitical stir.

Consumer spending bellwether Nike results are ahead

Nike’s (NKE) shares have run up about 18% ahead of the retail giant announcing quarterly results on Tuesday, which are expected to be buoyed by strength across all regions, excluding China. Revenue is expected to rise about a 6% to $11.48 billion with a focus to be on inventory levels. Nike has increased EPS estimates in 8 consecutive quarters, and only missed revenue expectations twice in that span. We think Nike’s sales outlook will be upgraded in 2023, as its most profitable region, China, has reopened. Staying on its outlook, it’s hoped excess inventory will reduce quicker than expected with Chinese demand increasing – and this this would help the sportswear giant pare back on promotional discounts, and that will ultimately aid in profitability. Investors will look for commentary on how it's going to accelerate consumer growth, after making key hires.

Earnings to watch

Earnings releases this week will take a back seat to the unfolding banking crisis. The key earnings to watch are Nike and Tencent with Nike reporting earnings tomorrow after the US market close with analysts expecting revenue growth of 6% y/y for the FY23 Q3 (ending 28 Feb) and EBITDA of $1.19bn down from $1.81bn a year ago. Tencent is expected to report no revenue growth in Q4 which essentially means that Tencent has barely grown since Q4 2021 as regulation is still creating headwinds.

This week’s earnings releases:

• Monday: Sunny Optical Technology, PDD Holdings
• Tuesday: RWE, Anta Sports, Partners Group, Nike
• Wednesday: Tencent, China Telecom
• Thursday: China Mobile, Accenture, General Mills, Darden Restaurants
• Friday: China Merchants Bank, Meituan, China Petroleum & Chemical

Economic calendar highlights for today (times GMT)

1400 – ECB President Lagarde to speak
0030 - Australia RBA Minutes