After a quiet start the week has become a little busier, with equities seeing some more movement in both directions having been range bound over recent weeks
The main headwinds for sentiment came from the US, with concerns over the debt ceiling moving up the agenda as well as a return to worries over the health of the banks after First Republic Bank reported first quarter earnings. Meanwhile, the Bank of Japan… did nothing, as usual.
First Republic suffered significant outflows in the first quarter, with customer deposits falling from $176 billion down to $105 billion. The drop would have been even larger in the absence of a $30 billion deposit from a consortium of the 11 biggest banks. It appears First Republic now needs to offload $50-100 billion of bonds and mortgages that are ‘underwater’ which could significantly impact their balance sheet, potentially wiping out the remaining equity. First Republic shares have fallen around 60% this week and are down almost 95% this year. A rescue or takeover would not come as a surprise. While the wider regional banks index in the US fell back somewhat, for the moment there was limited impact on the share prices of other US banks. The issues at First Republic are a reminder of what we said last month – the banking sector will take time to play out, and we have likely not seen the last of the smaller banks facing existential concerns, not least when we have not yet seen the full impact of rate hikes in terms of a US slowdown or recession.
The Bank of Japan meeting, which concluded today, saw a little more anticipation for a policy shift than usual as this was the first meeting under new Governor Kazuo Ueda. However, Ueda’s comments in recent weeks have suggested no significant policy shifts were on the horizon, and this was confirmed in today’s meeting, where the Bank left policy unchanged, with interest rates at -0.1% and Yield Curve Control continuing to keep the yield for the 10-year Japanese Government Bond “at around zero percent”. While the Bank did remove from their forward guidance the phrase that they “expect short- and long-term policy interest rates at their present or lower levels” they also announced a “broad perspective review of monetary policy” that would take around 12-18 months. So, it looks like the BoJ is in no hurry to make any changes.
The economic data saw the flash PMI data continue to hold up reasonably well across developed markets, at least at the overall level. The underlying numbers continue to point to manufacturing weakness being offset by resilience in the service side of economies. First quarter US GDP data was weaker than expected, with the economy growing by 1.1% on an annualised basis, some way below the 2% expected.
US politics have also been in the news this week with concerns over the debt ceiling becoming visible in market pricing. We have seen the spread between the yield on the 3-month US Treasury Bond over the 1-month bond begin to widen, suggesting that concerns are rising over a fiscal event in the summer. The debt ceiling situation is likely to come to a head at some point in July, though with tax receipts lower than expected, the ‘X date’ when the US can no longer pay its bills, may be slightly earlier. The cost to insure against US default, as seen in Credit Default Swaps, is low as a default is seen as an extreme tail risk, but it has risen sharply over recent days, and is higher now than during the global financial crisis and the last major debt ceiling drama back in 2011.
US politics and the debt ceiling is all about brinkmanship. House Speaker Kevin McCarthy (a Republican) brought to the House this week proposals for a budget, but these will not get through the Democrat controlled Senate. The focus should likely not be on if the debt ceiling will be raised because ultimately a compromise will be found – no rational politician would want to be associated with as US debt default – but the focus should be on how the ceiling is raised and the spending cuts required to get there. Back in 2011, most of the stock market turbulence and declines came after a political agreement was reached because the $2 trillion of spending cuts required to get a deal was far higher than expected and led to significant downgrades to growth expectations. We expect the debt ceiling noise to increase over the coming weeks before the can is kicked down the road at least for a few months.
We also had confirmation this week that President Biden will seek re-election in November 2024 with current Vice President Kamala Harris as his running mate. If elected, Biden will be 82 when he is sworn in, unless of course 76-year-old Donald Trump can defeat him (assuming Trump is the Republican nominee). Biden called on voters to back him so he can “finish the job”. Biden’s approval ratings are relatively weak, but he can take comfort from the Democrats doing better than feared in last year’s mid-term elections and Biden’s own favourable polling against Trump. Of course, Biden faces some significant economic challenges ahead of the election, with the significant risk of a recession, or at best anaemic growth before the end of the year, with unemployment set to rise as a consequence of interest rate hikes aimed at curbing inflation. The last time a President was re-elected despite a recession in their last two years in office was … 1900.
Have a good weekend,
Regards,
Anthony.
