US bank data key as investors focus on credit needs

A cluster of little-known weekly statistical releases showing the health of US banks may be a key driver of the appetite for risk.

Pepperstone head of research Chris Weston.

A cluster of little-known weekly statistical releases showing the health of US banks may be a key driver of the appetite for risk assets and safe havens in global financial markets in coming months.

The US Federal Reserve’s weekly “H.4.1” balance sheet updates and “H.8” reports on the assets and liabilities of US banks, and ICI updates on US money market fund inflows have become important talking points as investors try to gauge the credit needs of the banking sector after a recent loss of confidence.

US unemployment, average hourly earnings and CPI data long dominated market thinking on the interest rate outlook, but that changed when some US regional banks began to fail this month, leading to a major rally in bonds as the market swung from pricing rate hikes to cuts.

The strong risk appetite that emerged at the start of the year evaporated as the crisis quickly spread to Europe, where pressure on Credit Suisse soon led regulators to force a merger with UBS, and confidence in Deutsche Bank and others was tested.

Central banks kept lifting interest rates, and despite market pricing of cuts it’s by no means clear that increases have finished; the crisis isn’t bad enough just yet and inflation continues to be stubbornly high.

Ironically, the S&P 500 is little changed from where it was when the crisis began, thanks to a major reassessment of monetary policy expectations and rapid policy response from regulators.

Australia’s ASX 200, with its concentration of banks and cyclically exposed companies, like resources, hasn’t fared so well, although it appears to be forming a base.

But at this stage of the cycle, with recessions thought to be looming after the fastest interest rate rises, investors need to keep an eye out for signs of stress caused by a shortage of credit.

“If this banking crisis evolves – I suspect it will be contained and we will see some consolidation – markets will struggle to price risk, and that’s why we saw extreme moves in rates and bond markets,” said Pepperstone’s head of research, Chris Weston.

While expecting rate cut hopes to fade as bank shares rebound, Mr Weston said markets were finding it hard to price a slowdown in credit in small US banks, given their exposures to commercial real estate.

“If inflation is less of a concern, now it’s about pricing when slower growth really kicks in, and whether these (market-implied) rate cuts are actually anywhere near on the money,” he said.

Mr Weston said flows from US bank deposits to high-yielding money market funds have been “prolific” and investors should be watching the Fed’s credit facilities.

If the take-up declined, it would show bank capital needs were in better shape and they have enough liquidity, but an accelerated take-up of these facilities would point to further stress among banks.

While it’s increasingly clear that regulators will act rapidly to stop the spread of systemic risk, it’s equally clear that they will only do what’s needed, given the political cost.

Goldman Sachs said that two weeks after stress in the banking system began, the policy response was “a work in progress” – officials have refined the government’s message, clarifying that all depositors are likely to be protected, essentially in all cases, at all banks. But limits on the FDIC’s authority prevent them from eliminating all uncertainty by making the unlimited guarantee explicit.

“It seems unlikely that the Treasury, Fed, or FDIC will be able to meaningfully strengthen the FDIC’s implicit guarantee beyond where it now stands,” said GS strategists Alec Philips and Tim Krupa.

While noting that the Treasury has the capacity to provide a backstop for uninsured deposits if it becomes necessary, they said the past week demonstrated that the political hurdle was “high”.

“Secretary Yellen’s position on unilateral Treasury action was unambiguous,” they said.

“While we would not entirely rule out Treasury action if acute banking stress returns, the odds of a unilateral move from the Treasury appear very low.”

This leaves Congress as the only plausible source of a broad explicit guarantee on uninsured deposits, but the odds of congressional action on deposit insurance remain “fairly low.”

“While a number of Democratic lawmakers have expressed support for increasing the limit on deposit insurance, many Republican lawmakers have expressed scepticism, and some are clearly opposed,” they added.

Meanwhile, after looking at times when the KBW Banks index fell at least 12 per cent in three days, Canaccord chief market strategist Tony Dwyer found the S&P 500 rose 10.7 per cent on average before falling 11.4 per cent on average, compared to the level where the “signal” was triggered.

“In each case, a drop in the banks led to a relief rally that did not create a sustainable rise in the broader market,” Mr Dwyer said.

“We believe such sharp BKX (KBW index) weakness leads to an initial oversold bounce in the hopes the crisis is past, while the move back to the low is the realisation it may not be, due to less availability of money and its negative impact on economic growth.”

“In the current instance, prior to any issues in the regional banks, lending standards had already tightened to the level that suggested a recession is near. Higher regulatory scrutiny and capital requirements are likely to cause lending standards to tighten even further.”

He maintained that the regional bank crisis would “linger and cause volatility in both directions” while money availability continued to be the “main issue”.

“Our game plan remains the same; stay lighter in exposure and slightly defensive in sector allocation and stand ready to take advantage of any weakness when ‘bad news becomes bad news’,” he said.