Franklin Templeton’s Notes from the Trading Desk offers a weekly overview of what our professional traders and analysts are watching in the markets. As part of Templeton Global Equity Group, the European equity desk is manned by a team of professionals based in Edinburgh, Scotland, whose job it is to monitor the markets around the world. Their views are theirs alone and are not intended to be construed as investment advice.
It was interesting to see the MSCI World Index finish last week flat given the continued investor jitters. Regional performance was very mixed; the STOXX Europe 600 Index closed the week down 3.9%, the S&P 500 Index was up 1.4%, whilst the MSCI Asia Pacific was down 0.22%.1
The fear of contagion in the banking system following the collapse of Silicon Valley Bank (SVB) in the United States weighed on risk assets throughout the week. The future of Credit Suisse (CS) came into focus, so much so that the latest European Central Bank (ECB) interest-rate announcement almost became a sideshow. Shares of CS closed the week down 26% and the bank’s credit default swaps (CDS) hit new all-time highs. Regional banks in the United States came under pressure as investors became fearful of another meaningful bank run. Central bank supposed somewhat buoyed equities, as both the Federal Reserve (Fed) and the Swiss National Bank stepped in with measures to support ailing banks.
The latest Bank of America “Flow Show” report threw out some interesting datapoints. Last week saw another US$113 billion going into cash, its largest inflow since April 2020, and there was also a flight to quality in the credit space, with Treasuries seeing their largest inflow (US$9.8 billion) since May 2022.2 Emerging market debt saw an outflow of US$3.1 billion, its largest since November 2022.3 Notably, there was no capitulation witnessed in equity flows last week.
Credit Suisse collapse
Following the SVB woes in the United States, CS came under pressure last week and began to take further steps to strengthen liquidity. The stock had a trading range of nearly 40% last week, whilst its CDS surged to new all-time highs. CS had put the market on watch after it released its annual report on Tuesday, disclosing that outflows had continued through February and up until the reporting date in March. It also noted that it had identified a range of weaknesses and deficiencies in its financial reporting and internal controls. The main catalyst for the stock’s sizeable move lower on Wednesday was the news that the Saudi National Bank (CS’s largest shareholder) would refuse to provide more assistance to the bank. There was then a short-lived bounce on Thursday after the Swiss National Bank provided CS with access to a CHF 50 billion central bank liquidity facility.
The picture has of course changed once again from when we went home on Friday. Over the weekend, it was reported that UBS would acquire CS for CHF 3 billion. The Swiss government, the Swiss National Bank and FINMA endorsed the acquisition. The implied deal price is a significant discount to where CS shares were trading on Friday.
We have seen consistent language over the last week which suggests the recent events at SVB and CS are not systemic. But there are still plenty of nerves, with European banks remaining under pressure.
The ECB sideshow
There was also an ECB policy meeting last week on Thursday. The central bank had indicated at its previous meeting in February that it would raise interest rates by 50 basis points (bps) in March. However, with the market turbulence over the last week relating specifically to turmoil within the banking sector, investors were split on whether they would reconsider. European bank stocks have given up almost all of this year’s gains. The ECB hiked rates 50 bps as had been anticipated, bringing the deposit rate to 3%. The vast majority of board members voted for the hike. Three of four members wanted to pause to see how the current situation unfolds.
However, with core inflation rising in February and with ECB staff projections predicting inflation will still be above target by 2025, policymakers were not left with too much room in their fight against inflation—recall, they have not hiked rates as aggressively as the Fed has so far. Also, deciding not to tighten policy further would possibly have been viewed by the market as an admission of underlying vulnerabilities in the system.
In terms of inflation forecasts, the ECB stated that “inflation is projected to remain too high for too long” despite revising down inflation expectations. It now sees 2023 inflation at 5.3% (prior forecast 6.3%) and see 2024 inflation at 2.9% (prior forecast 3.4%). On future rate hikes, the ECB noted that any decisions will be dependent on data and that it wouldn’t be providing forward guidance. On the liquidity backstop, the ECB noted that it “stands ready to respond as necessary to preserve price stability and financial stability…and the ECB’s policy toolkit is fully equipped to provide liquidity support to the euro area financial system if needed.”
In her press conference, ECB President Christine Lagarde made it clear that there was more to do to challenge inflation, despite the current market volatility, stating her view that the banking sector issues remain contained for the moment.
That said, there are concerns of central bank policy errors, and some market observers were keen to draw parallels with Trichet’s 2008 policy error as he hiked rates while the markets slumped into the global financial crisis.
Interestingly, the market is now pricing a terminal rate marginally above 3%. Two weeks ago, the terminal rate was 3.984%.4 What a difference a fortnight makes!
Week in review
It was a tumultuous week for European equity markets, with focus shifting from stress in the US banking system to the Europe. Wednesday was firmly the worst day of the year so far for European stocks, as the STOXX Europe 600 Index closed the day down 2.9%. The index closed the week down 3.9% overall, closing back near the lows, and smashing below its 50- and 100-day moving averages, which are key technical markers.5 The stress was evident in credit markets too, as the German two-year yield dipped by an all-time record 41 bps on Monday, and then broke this record again on Wednesday, sliding more than 50 bps.
Cyclicals significantly underperformed defensives last week, as the risk-off mood continued. Unsurprisingly, bank stocks got crushed. Despite the broadly held view that issues at SVB and CS are isolated and not systemic, it didn’t seem to help market sentiment, as investors continue to question the impact on profits, rather than solvency and liquidity. Oil and gas stocks also came under pressure last week as many investors sold their winners as oil prices dropped more than 11%. Given market sentiment, defensive stocks outperformed, with food and beverage stocks seeing small gains overall and healthcare and utilities stocks flat to slightly lower overall. Interestingly, with bond yields falling, we saw a rotation into technology stocks which saw gains last week. It seemed as though big tech was viewed as a somewhat safe space.
On a week of risk-off market sentiment, it was interesting to see US indices close last week higher. The S&P 500 Index was up 1.4% last week, whilst the Nasdaq was up a notable 5.8%. As noted, tech stocks were largely seen as a safe haven last week, with communication services and info tech stocks finishing the week with solid gains. Similar to the dynamic in Europe, energy stocks fell, with West Texas Intermediate crude oil prices were down 13% on the week.
Focus remains on the fallout from SVB’s collapse and any read-across to the broader US banking sector. The Fed, Treasury and Federal Deposit Insurance Corp. (FDIC) announced that all SVB and Signature Bank depositors would be fully covered with a new facility, the Bank Term Funding Program (BTFP), to provide an additional source of liquidity. Regional banks were heavy again last week.
This weekend, a coalition of mid-sized banks asked regulators to extend the FDIC insurance to all deposits over the next two years, highlighting again the fear of contagion. There was huge volatility in US credit markets too last week, with the US two-year note shedding 74.8 bps on the week, its biggest weekly move since October 1987.
Focus will shift quite firmly to the Federal Open Market Committee (FOMC) rate decision this week. Data from last week showed that inflation does appear to be moderating. The University of Michigan inflation expectations came in at 3.8% its lowest reading since April 2021. The US February Producer Price Index (PPI) also came in lower at -0.1% month-on-month. The February Consumer Price Index (CPI) report came in at +0.4%, in-line with expectations, but showing continued moderation.
Given the contagion risk in the banking sector, the market is now pricing in rate cuts as early as June from the current 4.75% deposit rate. For the Wednesday Fed meeting, the market is pricing in a 25 bp hike, but there is a real chance of no change. Fed policymakers have a little more room to work with than the ECB, as they have hiked more aggressively in the last year. All eyes will also be on Chair Jerome Powell’s press conference, where he is likely to try his utmost to calm markets, whilst reiterating his commitment to tackle inflation.
Last week was fairly flat overall in Asia despite the turmoil in the banking sector, with the MSCI AC Asia Pacific Index closing the week down only 0.22%.
Japan’s equity market was one of the worst-performing markets, closing down 2.88%, with the banks in focus and a risk off mentality front and centre. The yield on the 10-yr JGB dropped about 10 bps last week.
To reassure markets, Prime Minister Kishida stated that the Japanese banks had adequate liquidity and capital. But despite his assurances, the banking and insurance sectors were the worst-performing sectors last week.
Focus turned to the effects that the recent bank turmoil in the United States and Europe might have on Bank of Japan (BoJ) monetary policy. The BoJ April meeting will be the first chaired by incoming Governor Kazuo Ueda, and is going to be closely watched for any pivot from the current ultra-loose stance.
Elsewhere, Kishida has, for some time now, urged big business to increase wages to compensate for the impact on households of rising living costs and to support the government’s agenda. This, to a certain degree, came to pass this week as companies raised wages by the most in decades, as the annual “shunto” spring wage negotiations were finalized.
China’s market closed the week up 0.63%, as global banking woes offset optimism about an economic recovery and further monetary support from Beijing.
The People’s Bank of China (PBOC) was busy last week, as it injected a larger-than-expected CNY481 billion into its financial system and at the same time cut the reserve requirement ratio (RRR) for many banks by 25 bps in a bid to ensure liquidity and boost the economy.
To maintain stability, PBOC Governor Yi Gang was reappointed for another year, despite the rumour that he’d be retiring.
Large-capitalisation stocks outperformed last week, with construction, telecom and financials leading. New home prices in 70 of China’s largest cities rose 0.3% in February, above the 0.1% gain in January and marking the fastest increase since July 2021, according to the National Bureau of Statistics. This comes as a relief to the real estate sector, which for many months was under pressure due to (the new defunct) COVID-19 restrictions. The state-owned enterprise (SOE) construction names closed the week higher. Artificial-intelligence-related stocks also moved higher, as Baidu launched its own Chatbot Ernie. Meanwhile, solar stocks fell as the EU Commission officially proposed the Net Zero Industry Act to scale up manufacturing of clean technologies in the European Union.
On the political front, President Xi Jinping is visiting Russia March 20–22, so all eyes will be on any forthcoming announcements.
Macro week ahead highlights
The latest FOMC rate decision will be the focus this week. The Bank of England and the Swiss National Bank are also meeting this week and will weigh the fallout from the collapse of SVB and CS.
Monday 20 March
- Eurozone – Foreign Trade
- UK Rightmove House Prices
- Switzerland Domestic Sight Deposits
- Germany PPI
Tuesday 21 March
- Germany ZEW Survey
- France Retail sales SA year-over-year
- UK Public Finances (PSNCR); Central Government NCR; Public Sector Net Borrowing; UK PSNB ex-Banking Groups
- Switzerland Exports & Imports Real; Watch Exports; Money Supply M3; KOF Institute Spring Economic Forecast
- Netherlands House Price Index
- Eurozone EU27 New Car Regs; ZEW Survey Expectations; Construction Output
- US Philadelphia Fed Non-Mfg. Activity; Existing Home Sales
Wednesday 22 March
- UK CPI Inflation; RPI; PPI; UK House Price Index; CBI Trends
- Norway Unemployment Rate Trend
- Netherlands Consumer Confidence Index
- Italy Current Account Balance
- Eurozone ECB Current Account SA
- US FOMC Rate Decision; Mortgage Applications
Thursday 23 March
- Swiss National Bank Policy Rate Decision
- Bank of England Policy Decision
- Norges Bank Rate Announcement
- Eurozone – Consumer Confidence
- Japan – Core CPI
- US Current Account Balance; Initial Jobless Claims; Chicago Fed Nat Activity; New Home Sales
Friday 24 March
- UK Retail Sales; Flash Composite PMI Survey; GfK Consumer Confidence
- Euro-Area Flash Composite PMI Survey
- Sweden PPI
- Spain gross domestic product (GDP); PPI
- Norway Credit Indicator Growth
- Netherlands GDP
- Germany Import Price Index
- France Wages
- US Durable Goods Orders; PMI-Manufacturing; PMI-Services and PMI-Composite; H.8 – Assets and Liabilities of Commercial Banks in the United States
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