March 2023 was a good month for investors, except for commodities (CRB index) and Banks, almost all assets increased in value. However, the risk of a financial crisis has increased which could significantly impact the global economy.
As usual, in recent months, investors and economists were again very concerned last month about the excessive inflation, the significant risk of a recession and the war in Ukraine. However, March 2023 also marks the beginning of a new threat; the possibility of a financial crisis.
In March, it became clear that due to the rise in interest rates, the US banking industry now has a book loss of USD 675 billion on bonds it holds in its portfolio. The banks do not have to record these losses as long as these bonds are held and not redeemed until maturity. However, it becomes a problem as soon as customers of the bank request their funds held at the bank. In that case, the bank must sell its bonds to repay the customer the deposited money. Because the bank sells the bonds before maturity, it must also record the loss it incurs on the bonds. In March, it became clear what this can mean for a bank when both Silicon Valley Bank (SVB) and Signature Bank in the US and Credit Suisse in Europe had to be rescued to prevent an imminent crisis of confidence in the financial system. In the case of SVB, customers of the bank attempted to withdraw USD42bn in deposits on March 9 alone, representing 20% of the balance sheet total. Because SVB had to sell bonds for this and take the loss on it, the bank was immediately insolvent. As usual, the financial markets panicked, and Signature Bank and Credit Suisse could only avoid bankruptcy by accepting a takeover of the bank. Thanks to quick and firm intervention by the Central Banks, Deutsche Bank could be prevented from collapsing too, and confidence returned to the financial markets.
However, the book losses at banks on bonds continue to hang over the economy and financial markets like the sword of Damocles. Especially at an interest rate of 4% or more on UST10, the losses are enormous, and banks can become insolvent very quickly if confidence is lost. In Switzerland, the banks have a combined balance sheet that is 5x larger than the economy. Although this is considerably lower in the US, regional “small” banks account for 50% of all outstanding loans. In the past, interest rate hikes by the FED have regularly led to a financial crisis, and the dangers have not yet passed this time either.
Given the risks, it is to be hoped that the rate hikes by the FED (+25bp), the ECB (+50bp) and the BoE (+25bp) in March will have been the last of this year. This is mainly because inflation is now falling everywhere, as in the Netherlands, for example, and the inverted yield curve in the US indicates that a recession is imminent. It means the 2-year US treasury has a higher yield at 3,85% versus the 10-year US Treasury at 3,38% (see for spread since 1980 chart below right).
March 2023 was a good month for investors, except for commodities (CRB index) and Banks, almost all assets increased in value. The contrast in performance between 2023Q1 and 2022 is remarkable.
Despite the US banking crisis and disappointing earnings prospects, US equities outperformed. Partly because of this, equities in the US appear expensive compared to equities outside the US, and financials seem attractive to an investor who likes a bit more risk.
Thanks to the (short-lived) banking crisis in March, the 10-year interest rate dropped considerably. Given prospects for a further fall in inflation, a 3.5% yield on UST10 still looks attractive.
While March was disappointing for commodities, it was a good month for precious metals such as silver and gold. Going forward, it will be interesting to see if gold can break the resistance of USD 2075, and it could indicate a return of the March banking crisis and the inflation of the 1970s.
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