Equity market momentum stalled on Friday due to concerns in the banking sector. On the bright side, the US labour market report for February gave minor indications of wage pressures easing.
Last week ended on a gloomy note, with the American Silicon Valley Bank (SVB), which primarily caters for the financing needs of growth-phase technology companies, facing payment difficulties. SVB’s difficulties raised concerns in the markets about a larger deposit run in the banking sector, which has impacted especially the stocks of smaller banks. Last week also saw a decline in the interest rate level and heightening volaitlity.
The rise in interest rates has caused the bonds in banks’ balance sheets to lose market value. SVB got into trouble because it was forced to sell bonds from its balance sheet at a market price that was lower than their book value to be able to meet customers’ withdrawals. In terms of the general market development, SVB’s demise as a relatively small bank has little significance; the real cause for concern here is a widespread contagion in the banking sector and the possibility of a deposit run, particularly from smaller banks.
In an effort to prevent bank runs and stem contagion, the US Federal Reserve announced a new emergency loan programme for American banks over the weekend. The programme’s objective is to ensure that all depositors will have access to all their money in all circumstances. In addition, the conditions of the normal lending mechanism were eased. The depositors with SVB and the other two banks that came down will have access to their deposits in full on Monday. The announced measures are expected to prevent any deposit runs from US banks and dissipate concerns over the banking sector.
Key interest rate cuts expected again by markets already this year
This week, all eyes will be on the banking sector, but further indications of inflation will also be in store and, with that, the central banks’ interest rate hike path. Inflation figures remain a focus of interest, as inflation has not moderated as fast as expected.
The US labour market report published last week presented a contradictory picture of inflation. Slightly more jobs than expected (311,000) were created in the economy, but the unemployment rate rose to 3.6 per cent (3.4 per cent in January). Average hourly earnings, a key factor in terms of inflationary development, grew +4.6 per cent year-on-year. The growth rate was slightly below expectations (+4.7 per cent), but exceeded January’s growth (+4.4 per cent). Pay raises have a positive impact on consumers’ purchasing power, making it possible for companies to raise prices, which in turn maintains inflation. On the other hand, a rising unemployment rate eases wage pressures.
More information about the inflation level will be available when the US inflation figures for February are published on Tuesday, 14 March. Headline inflation is expected to have eased to +6.0 per cent (+6.4 per cent in January). Core inflation (i.e. inflation less energy and food) is expected to have moderated to +5.5 per cent (+5.6 per cent in January). The markets would be disappointed if core inflation remained at the January level, increasing expectations of tightening monetary policy.
The US Federal Reserve’s next steps will be known soon enough: the Fed’s interest rate meeting will be held on Wednesday, 22 March. The markets are currently pricing in an interest rate hike of 1–2 increments, with a hike of one increment, i.e. 0.25 percentage points, being the more likely scenario. However, pricing in the fixed income market has recently shown strong volatility; Goldman Sachs, for example, no longer expects a hike in March.
The markets are now pricing in a peaking of the US key interest rate in early summer, at around 5.25 per cent. After their temporary absence from expectations, the interest rate cuts that the markets had expected to take place later this year made a comeback last week. This would have likely weakened the economic growth outlook. This is also supported by the flashing red of the recession indicator, i.e. the US 10- and 2-year treasury bond yield curve, which has not been this strongly negative since the 80s.
The European Central Bank will hold its interest rate meeting on Thursday, 16 March. The markets are expecting a hike of two increments, i.e. 0.5 percentage points, which has also been suggested by President Christine Lagarde in her recent statements. Recently, expectations that monetary policy will be tightened more and for longer than previously anticipated have intensified. The markets are expecting that the central bank will raise interest rates by another three increments during the rest of the year, bringing the key interest rate to 3.5–3.75. The key interest rate is not expected to peak until the latter half of the year. The hikes are thus expected to continue longer than in the USA.
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