Global banking crisis, and its impact on markets. On March 10th the United States saw the biggest failure of a US bank since the global financial crises as a major lender succumbed to a classic bank run. Silicon Valley Bank’s customers frantically pulled their money from the lender before US regulators had to take control. Unfortunately, the collapse panicked markets and increased pain on weaker financial institutions that were already struggling with the consequences of soaring interest rates and other practices of mismanagement. Soon after Signature Bank was shut down, First Republic Bank needed to be propped up, and a global systemically important bank, Credit Suisse, was saved by rival firm UBS.
Fortunately, there has been some relative calm restored to the sector thanks to the emergency cash provided by central banks and some of the industry’s strongest players. The S&P 500 index had an incredibly volatile month but will end about even month end, the NASDAQ index outperformed, gaining 3% as the tech sector was considered a haven during the banking turmoil, and the bank heavy Dow Jones index traded marginally down throughout the month. Unfortunately, the bond market has not provided any source of safety over recent weeks as the stress on the economy has ignited some of the wildest swings in the Treasury market in years as seen in the chart below. This high volatility reflects the general uncertainty of investors in the current moment who are trying to assess how the crisis will interact with the economy and the Federal Reserve’s plans for inflation.
Inflation still persistent. Looking to the brightside, a key factor in reducing inflation in early 2023 has been a recent decline in energy and food prices. However, this does not impact core CPI, which excludes food and energy, and is becoming more commonly looked to as a more reliable measure of inflation due to extraneous market factors which create volatility in food and energy prices. In February, CPI increased 6% in the last 12 months and core CPI increased 5.5% year over year. Unfortunately, while goods price inflation has started declining, inflation continues to be driven by strong service price increases and cost pressures from tight labor markets as seen in the chart below. As a result, the Fed voted to raise interest rates by 0.25% in its March meeting and released a median forecast of one more 0.10% hike in the coming year. The Fed’s baseline expectations show zero interest rate cuts this year.
Fears of a weaking U.S. dollar amidst Russia/China Alliance and U.S. spending. In President Xi Jinping’s recent visit to Russia, President Putin subtly claimed that they are in favor of using the Chinese yuan for settlements between Russia and the countries of Asia, Africa, and Latin America. Historically, the reason America has been able to claim it is the world’s hegemonic power is because the dollar gives Washington power to unilaterally sanction and spend freely since its debt will be bought by the rest of the world.
However, in recent years, shares of dollars in global central bank reserves have fallen steadily and countries are trying to build international payment systems outside of the dollar-dominated SWIFT system. Saudi Arabia has embarked on plans to price its oil in Chinese yuan, and India settles most of its oil purchases in nondollar currencies. The dollar’s unique status has given America decades of spending without concern while accruing debt, and the Fed has solved a series of crashes by expanding its balance sheet for the same reason. But as the new proposed budget in Congress raises the U.S. debt/GDP ratio to a staggering 109%, Congress may need to rethink the policies adopted.
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