Walking the tightrope

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1820
Written by Citadel Global Director, Bianca Botes

The recent fallout in the banking sector left many wondering whether the United States (US) Federal Reserve (Fed) and other central banks have the capacity to combat inflation through ongoing rate hikes without causing further fallout in the banking sector.

Key themes for this week include:

  • Central banks proceed with rate hikes
  • Tight US labour market persists
  • Equity markets mixed as investors digest central bank action
  • Dollar tumbles in face of less hawkish Fed

Striking balance

We started this week with markets divided on whether the Fed would proceed to hike interest rates in the face of the banking crisis. While the Fed was far less hawkish than its peer, the European Central Bank (ECB) which hiked rates by 50bps last week, the Fed stuck to a 25 basis point hike, in line with most market participants’ expectations.

One might think that this move was not a deviation from the Fed’s “fight inflation at all costs” stance, because it not only hiked rates further, it was also in line with market expectations. However, when compared to the extremely hawkish testimony by Fed Chairman, Jerome Powell, in front of congress only a few weeks ago, you start to realise that is probably as close to a U-turn on interest rate hikes as one can expect from the Central Bank.

Before the collapse of Silicon Valley Bank, markets anticipated a 50 basis point hike in March, and at least one more 25 basis point hike to follow. Two weeks on and following Wednesday’s 25 basis point hike, the markets are not only starting to position for a rate-hike pause by the Fed, it is even calibrating for a potential rate cut later in the year.

Central bank action this week did not end with the Fed. While markets were largely positioned for the Bank of England (BoE) to pause rate hikes in the near term, the United Kingdom’s (UK’s) inflation unexpectedly ticked up in February, to 10.4%. On Thursday, the BoE also raised its key bank rate by 25 basis points to 4.25%, in line with expectations, pushing borrowing costs to their highest levels since the 2008 financial crisis. The BoE is trying to bring inflation back to its 2% target and expectations remain in place for inflation to decrease significantly over the next few months. UK policymakers have warned that should evidence of persistent price pressure arise, the bank will move to adopt further tightening. The BoE also reinforced that, in light of the banking crisis, the UK banking system remains resilient and maintains robust capital coupled with strong liquidity positions.

With the recent fallout in the Swiss banking system, where Union Bank of Switzerland (UBS) acquired troubled lender, Credit Suisse, for $3 billion to avoid its collapse, there was a lot of focus on the Swiss central bank too. The Swiss National Bank (SNB) raised its policy rate by 50 basis points to 1.5%, following a similar move in December and bringing Swiss borrowing costs to their highest levels since November 2008. The Central Bank also said that additional hikes in the policy rate could not be ruled out as it works to ensure price stability over the medium term. To provide appropriate monetary conditions, the SNB also remains willing to remain active in the foreign exchange market, as necessary.

While risk appetite improved and the banking crisis seems to be contained for the time being, it remains a risky environment. There is continued focus, on the regional US banks, specifically First Republic Bank. Analysts at Morgan Stanley estimate that a potential buyer for the embattled First Republic Bank would need to absorb $26.8 billion in mark-to-market losses from First Republic’s loan and securities portfolios, while an extra $9.5 billion is needed to recapitalise the bank.

As such, central banks find themselves in a precarious position. They need to balance not adding further pressure to the banking sector, while still combatting inflation head on.

DATA IN A NUTSHELL

While interest rate decisions took center stage this week, there were some key data releases. US initial jobless claims fell by 1 000 from the previous week to 191 000 for the week ending 18 March, compared to expectations of 197 000. The result continues to reinforce the narrative of a stubbornly tight labour market, which is in line with the hot payroll figures for February and the Fed’s outlook of ongoing low unemployment. The tight job market is forcing employers to raise wages to attract and keep staff, which in turn is magnifying inflationary pressure on the American economy and is fueling the Fed’s need to continue tightening monetary policy.

Factory gate prices of goods produced by UK manufacturers eased for a seventh month to 12.1% year-on-year in February, down from 13.5% in the previous month and missing market expectations of 12.4%. It was the lowest reading since February 2022, as six of the 10 product groups showed downward trends, led by the negative contribution of petroleum products. On a monthly basis, output producer prices decreased 0.3%, from a 0.5% growth in January, and missed market expectations of a 0.2% increase.

The Composite Leading Business Cycle Indicator in South Africa inched down 0.1% from the previous month, following a downwardly revised 1.9% fall in December. This marked the fourth consecutive period of declines in business indicators. Annual inflation in South Africa crept up to 7% in February from 6.9% in the previous month, its first increase since October 2022. This moved against market expectations which was for inflation to remain steady at 6.9%.

TECH STOCKS REBOUND

US stocks extended gains on Thursday, with the Dow Jones jumping nearly 400 points, the S&P 500 increased by 1.6%, and the Nasdaq Composite saw a 2.2% increase, recovering from a 1.6% slump in the previous session. Tech shares led the charge, with Microsoft, Meta and Apple, gaining 3%, 3.5% and 1.9% respectively, as Treasury yields declined. Bank shares also rebounded despite Treasury Secretary, Janet Yellen, telling Congress she hasn’t considered or discussed blanket insurance or deposit guarantees. Meanwhile, cryptocurrency company, Coinbase lost 12% after being downgraded by investment bank, Oppenheimer, following a Wells notice from the Securities and Exchange Commission saying it is bringing enforcement action against the company.

The FTSE 100 had a harder time on Thursday, closing 0.85% lower at 7 500, underperforming its European counterparts after the BoE raised its key bank rate by 25 basis points. The move was in line with the ECB’s and SNB’s rate increases this month, as it opted to prioritise its fight against soaring inflation, despite significant near-term volatility for European banks. Lenders bore the sharpest losses of the session, led by a near 3% tumble for HSBC and a 2% decrease for Barclays.

European equity markets were largely subdued during afternoon trading on Thursday, as investors digested interest rate hikes from central banks including the Fed, the BoE and the SNB. The STOXX bank index fell more than 2%, after Citigroup downgraded Europe’s banking sector rating to “neutral” from “overweight”, saying the likely ongoing monetary tightening adds to worries stemming from the turmoil in the global banking sector.

The JSE FTSE All Share Index climbed nearly 0.5% to close at 75 585 on Thursday, its highest level in nearly two weeks, a day after the Fed raised the fed funds rate by an expected 25 basis points and hinted it was nearing a pause in its hiking cycle. Heavyweight tech stocks Naspers and Prosus posted sharp gains, adding 4.7% and 6%, tracking Tencent’s rally in Hong Kong, after it reported a return to revenue growth in the fourth quarter of 2022. Financial and industrial stocks advanced nearly 1% each. Domestically, the International Monetary Fund warned, on Wednesday, that South Africa’s growth is set to decelerate sharply this year due to power cuts and the economy risks stagnation. It announced a bleak forecast for 2023 GDP growth of only 0.1%.

LESS AGGRESSIVE FED BOLSTERS GOLD

WTI crude futures traded to $70/barrel towards the end of this week. US Energy Secretary, Jennifer Granholm, told lawmakers that it will be “difficult” to refill strategic oil reserves this year. This prompted markets to speculate that the US government would likely only start buying oil at much lower levels. Signs of continuous strong supply from Russia added additional pressure to prices. Even as investors remain weary amid the ongoing banking sector uncertainties, the US oil benchmark is on track to finish the week higher, supported by bets that the Federal Reserve will soon pause interest rate hikes, coupled with optimism over China’s demand recovery.

Gold prices climbed to trade above $1 970/ounce on Thursday after gaining 1.6% in the previous session, as the Fed U-turned on its aggressive tone, hinting at only one more rate increase, decreasing the opportunity cost of holding non-yielding gold in the near future.

Copper futures traded at $4.00/pound, rebounding from the two-month low of $3.90/pound, touched on 16 March on the back of the dollar’s retreat, evidence of tight supply, and hopes of strong demand. Mining exports from major producer, Peru, sank nearly 20% annually in January due to the widespread protests, while inventories at the Shanghai Futures Exchange continued to remain at record-low levels. In addition, increased demand expectations for top consumer, China, were underpinned by the People’s Bank of China’s surprise cut in the reserve requirement ratio, the country’s latest measure to spur higher economic activity after its stringent COVID-19 lockdowns.

DOLLAR ON TRACK FOR LONGEST LOSING STREAK IN TWO AND A HALF YEARS

The US Dollar Index remained under pressure on Thursday, trading around the low levels seen in early February, and was on track to book a sixth consecutive session of losses, making this its longest losing streak in two and a half years. Markets continue to digest the latest Federal Open Market Committee (FOMC) statement and comments from Fed Chair, Jerome Powell, with market participants split on whether the Central Bank will cut rates this year, despite Powell pushing back against such moves in 2023.

The euro gained ground to reach $1.09, its strongest level since February, as investors digested the latest FOMC meeting minutes. The Fed is expected to deliver another 25bps hike in May, before pausing the tightening campaign. In contrast, in Europe, ECB President, Christine Lagarde, said that inflation remains far too high and that a robust strategy going forward is essential. She further added that bringing inflation back to 2% over the medium term is non-negotiable, strengthening bets of higher interest rates and a faster pace for quantitative tightening, despite the recent chaos in the banking sector.

The British pound held above $1.23, approaching its strongest levels since June 2022 following a 25 basis point interest rate hike by the BoE, with the central bank leaving the door open for further rate hikes should inflation persist. The sterling was also supported by pressure on the greenback amid the dovish tone from the Fed in its latest meeting.

The South African rand gained momentum against the greenback, on the back of broad-based dollar weakness, to trade near R18.10, its strongest level in over a month, putting distance between its current levels and the near three-year low of R18.60 hit on 21 March. Domestically, a surprise uptick in South Africa’s inflation reinforced expectations that the country’s central bank would lift the repo rate by 25 basis points to 7.50% at its meeting on 30 March. South African Reserve Bank (SARB) Governor, Lesetja Kganyago, has repeatedly reiterated that the SARB would be unwavering in its duty to bring inflation to a sustainable level, but that it also needs to deal with a struggling economy.

The rand is trading at R18.11/$, R19.62/€ and R22.24/£.