Stock markets in the US and Europe are being driven by positive US earnings and strong economic data in China. The data is bringing a more optimistic tone to weeks of uncertainty and concerns as traders concentrated on the potential developments in US monetary policy.
Traders have been following the start of the earnings season in the US where the banking crisis left a number of concerns about the sector’s health. The failures of SVB and Signature Bank have fuelled worries among investors that banks could be exposed to a flight in deposits.
The publication of strong earning figures among the largest banks in particular has served in alleviating these concerns and could help drive the market to higher values. The improving sentiment regarding the banking sector could also overflow to other market segments.
Some US banks have missed estimates and could pull the market down to a certain extent. Other large banks are expected to reveal their results in the following days which could fuel some volatility.
“A tale of two very different banking giants has unfolded as Goldman Sachs NYSE:GS was hit by a dent in deal making, while the good times rolled for Bank of America NYSE:BAC, which reaped big windfalls from higher interest rates,” said Susannah Streeter, head of money and markets at Hargreaves Lansdown. “The underlying story betrays more trickier times ahead for both banks. Volatility is expected to continue to affect the markets, which Goldman’s business is so highly interlinked with, while Bank of America’s net interest margins are set to be eroded as more customers scarper in the search for higher returns elsewhere, forcing it to offer better rates.”
Inflows from the worried customers of smaller banks, following SVBs collapse, haven’t changed the overall direction of deposits seeping away into money market funds offering higher yields.
“European banks have also followed their American counterparts to the upside as banking concerns retreated and as the European Central Bank could move toward smaller interest rate increments,” said Ahmed Negm, Head of Market Research MENA at XS.com. “The latter could give the market more breathing room on top of strong earnings from some major European companies.”
Comparisons with US Savings & Loans crisis
The initial ramifications of the recent banking crisis have been evident for investors in banking stocks, with significant drops observed in the rates and equity markets. US two-year rates, for example, fell to a low of under 3.8% while the S&P index experienced a decline before recovering as fears of market contagion subsided.
“These events draw a clear comparison to the Savings and Loans Crisis of the 1980s, during which the S&P index recorded a 15% drop while two-year rates fell from 17% to 12%,” explained Pierre Roke, Senior Analyst at Validus Risk Management. “If the comparisons continue, we could easily see more volatility ahead.”
- IPO Radar: Monzo, CoreWeave, Odyssey Therapeutics
- Share Tip: FTSE 250 financial services provider in an enviable position
- Three sectors poised for a Trump victory boost
In addition to market volatility, Roke thinks we are likely to see a longer lasting effect on the operations of the banking sector as a whole, particularly within the small to medium US banks (under $250 billion assets). “Given their importance within the economy, we anticipate that these banks will face increased regulatory scrutiny, which may lead to closer alignment with the European one-tier regulatory system, focusing on tighter liquidity and capital ratios within the smaller banks,” he said.
Heightened risk of bank runs
Following the crisis, there has been a notable trend among banks tightening their lending standards to improve their balance sheets. While this could be interpreted as a pre-emptive response to a potential regulatory change, Roke believes that the more probable reason is the heightened risk of bank runs in the small to medium US banking sector.
“As a result, we expect these tighter lending standards to have a similar impact to that of tighter monetary policy, which will effectively partly bridge the gap between the pre-bank crisis US terminal rate of 5.5% and the current rate of 3.7%,” he noted.
While the focus will ultimately return to the economic fundamentals (employment and inflation), it is too early to call victory on the banking crisis and it remains to be seen how banks will adjust their risk management practices to prevent future crises.
Risk managers should prepare themselves for increased market volatility and difficult funding conditions. If SVB’s foibles have taught us anything, it is to be prepared for even the most “unlikely” of market conditions.
