The Fed raised its funds rate by 25bps to a target range of 4.75-5% yesterday, in a sign of confidence that it does not believe a financial crisis is upon us. Rather, it said, policies are in place to absorb and deal with any further bank runs, and inflation remains our prime concern.
Treasury yields fell across the yield curve. Stocks fell too. But was this the effect of a slightly hawkish Fed statement, increasing the risk of recession? Or was it in response to a simultaneous statement by Treasury Secretary, Janet Yellen that new bank regulations are being considered?
Embracing the crisis
Jay Powell argued that there is no threat to macroeconomic stability (the banking system is ‘sound and resilient’) arising from the bank crisis. And because of the crisis, there is no need to raise rates by the 50bps thought likely by the market just a few weeks ago. The banking crisis is equivalent to a rate hike, as it is tightening credit conditions.
And so the bank crisis can help in the war on inflation. It is ‘love thine enemy’ time.
The Fed’s growth and unemployment projections are still based on a soft landing scenario (unemployment peaking at 4.6% late this year, GDP growth falling to 0.4% this calendar year, followed by 1.2% next year). With inflation falling steadily – core PCE is to fall below 3% next year, according to a consensus of economists.
The bond market thinks differently, judging by the 50bp 2yr/10yr yield inversion, which many economists believe is predicting a recession. Some, such as Danny Blanchflower*, believe the Fed will be forced into a policy U-turn, and there will be cuts by the autumn. This contrasts the Fed’s news dot chart, which suggests a further hike to come.
Elsewhere
The Fed’s hike validates the rate hikes seen elsewhere, such as last week’s ECB 50bps hike last week, at which chair Christine Lagarde also reiterated her determination to focus on inflation.
The Bank of England,** which was thought ready to call an end to its rate hikes, may be feeling in need of a further 25bps hike when it meets today. This morning saw a surprise rise in February headline and core inflation, while growth-related data has been not-as-bad-as-expected.
Credit Suisse ‘CoCos leaves a bad taste in the mouth
Contingent convertible ‘Advanced Tier 1’ capital, otherwise known as ‘CoCos,’ were a form of hybrid bank capital introduced after the GFC. It is a junior bond that, when a bank’s balance sheet is under stress, automatically converts into equity. Equity that can absorb any losses.
CoCos proved popular with investors because they offer a higher yield than most other bank debt. This reflects the risk of them converting into equity and potentially seeing the share price shrink if losses have to be absorbed. Thanks to strong demand, banks have been big issuers of CoCos since the GFC, using them to boost their core capital ratios without having to issue equity (which dilutes existing shareholders).
But we now know that Credit Suisse CoCos came with small print that some investors didn’t read. Instead of converting into equity, they lost all their value.
They bypassed the equity stage. Oddly, while equity owners will get some share value from the merger with UBS, the CoCos owners will get nothing, losing CHF 17bn.
The idea of a bondholder ranking below an equity holder is unusual (unheard of) in finance. There is speculation that a group of Asian investors may litigate.
The problem for other banks is that Credit Suisse’s unusual CoCos may raise the cost of using them for other banks as investors become wary. And if the cost of bank capital goes up, bank profitability may reduce.
CoCos worked well for Credit Suisse the first time they were tested. But have left a sour taste in the mouths of investors in CoCos everywhere.
The risk of recession may have risen
Investors should remain invested in diversified, multi-asset portfolios that invest in bonds, equities and other asset classes. The risk of recession must be higher than the Fed allows, given the risk of further mishaps in the financial system while the Fed raises rates to fight inflation.
*Danny Blanchflower is a British-American labour economist and academic. He is a tenured economics professor at Dartmouth College, Hanover, New Hampshire.
** At the time of this market commentary going to publication, the Bank of England announced a 0.25bps interest rate rise.
Ready to find out more?
At Brite Advisors USA, we work with UK ex-pats all over the USA on their investment needs, both retirement and non-retirement. Our US-based advisory team seeks to provide an outstanding experience for all clients.
We facilitate UK pension transfers using UK Self-Invested Personal Pension Plans (“SIPP”) provided by UK-regulated pension trustees for clients who want to save for their retirement by taking advantage of potential stock market growth.
No Investment Advice: This financial commentary is for informational purposes only and is not intended to be, and should not be, construed as an offer to sell or a solicitation of an offer to buy any security or financial instrument or invest in any equity or investment strategy. It should not be used to form the basis of any investment decision.
Investment Risks: There are risks associated with investing in securities and past performance is not indicative of future results. Always seek professional advice before investing.
Not Legal/Tax Advice: This financial commentary is not intended to be, and should not be construed as, legal, regulatory, tax, or accounting advice. Always seek professional advice and consult with your legal counsel, tax and accounting advisors when contemplating any course of action.
Discover the pros and cons of timing the market vs. time spent in the market. Explore the emotional challenges, risk factors, and potential returns of these investment strategies to make informed financial decisions.
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Each of the stock market sectors have companies worth looking at. In this article we highlight some of the most promising companies in each of these 11 sectors that could potentially provide investors
Taking Stock: The Fed – love thine enemy
The Fed raised its funds rate by 25bps to a target range of 4.75-5% yesterday, in a sign of confidence that it does not believe a financial crisis is upon us. Rather, it said, policies are in place to absorb and deal with any further bank runs, and inflation remains our prime concern.
Treasury yields fell across the yield curve. Stocks fell too. But was this the effect of a slightly hawkish Fed statement, increasing the risk of recession? Or was it in response to a simultaneous statement by Treasury Secretary, Janet Yellen that new bank regulations are being considered?
Embracing the crisis
Jay Powell argued that there is no threat to macroeconomic stability (the banking system is ‘sound and resilient’) arising from the bank crisis. And because of the crisis, there is no need to raise rates by the 50bps thought likely by the market just a few weeks ago. The banking crisis is equivalent to a rate hike, as it is tightening credit conditions.
And so the bank crisis can help in the war on inflation. It is ‘love thine enemy’ time.
The Fed’s growth and unemployment projections are still based on a soft landing scenario (unemployment peaking at 4.6% late this year, GDP growth falling to 0.4% this calendar year, followed by 1.2% next year). With inflation falling steadily – core PCE is to fall below 3% next year, according to a consensus of economists.
The bond market thinks differently, judging by the 50bp 2yr/10yr yield inversion, which many economists believe is predicting a recession. Some, such as Danny Blanchflower*, believe the Fed will be forced into a policy U-turn, and there will be cuts by the autumn. This contrasts the Fed’s news dot chart, which suggests a further hike to come.
Elsewhere
The Fed’s hike validates the rate hikes seen elsewhere, such as last week’s ECB 50bps hike last week, at which chair Christine Lagarde also reiterated her determination to focus on inflation.
The Bank of England,** which was thought ready to call an end to its rate hikes, may be feeling in need of a further 25bps hike when it meets today. This morning saw a surprise rise in February headline and core inflation, while growth-related data has been not-as-bad-as-expected.
Credit Suisse ‘CoCos leaves a bad taste in the mouth
Contingent convertible ‘Advanced Tier 1’ capital, otherwise known as ‘CoCos,’ were a form of hybrid bank capital introduced after the GFC. It is a junior bond that, when a bank’s balance sheet is under stress, automatically converts into equity. Equity that can absorb any losses.
CoCos proved popular with investors because they offer a higher yield than most other bank debt. This reflects the risk of them converting into equity and potentially seeing the share price shrink if losses have to be absorbed. Thanks to strong demand, banks have been big issuers of CoCos since the GFC, using them to boost their core capital ratios without having to issue equity (which dilutes existing shareholders).
But we now know that Credit Suisse CoCos came with small print that some investors didn’t read. Instead of converting into equity, they lost all their value.
They bypassed the equity stage. Oddly, while equity owners will get some share value from the merger with UBS, the CoCos owners will get nothing, losing CHF 17bn.
The idea of a bondholder ranking below an equity holder is unusual (unheard of) in finance. There is speculation that a group of Asian investors may litigate.
The problem for other banks is that Credit Suisse’s unusual CoCos may raise the cost of using them for other banks as investors become wary. And if the cost of bank capital goes up, bank profitability may reduce.
CoCos worked well for Credit Suisse the first time they were tested. But have left a sour taste in the mouths of investors in CoCos everywhere.
The risk of recession may have risen
Investors should remain invested in diversified, multi-asset portfolios that invest in bonds, equities and other asset classes. The risk of recession must be higher than the Fed allows, given the risk of further mishaps in the financial system while the Fed raises rates to fight inflation.
*Danny Blanchflower is a British-American labour economist and academic. He is a tenured economics professor at Dartmouth College, Hanover, New Hampshire.
** At the time of this market commentary going to publication, the Bank of England announced a 0.25bps interest rate rise.
Ready to find out more?
At Brite Advisors USA, we work with UK ex-pats all over the USA on their investment needs, both retirement and non-retirement. Our US-based advisory team seeks to provide an outstanding experience for all clients.
We facilitate UK pension transfers using UK Self-Invested Personal Pension Plans (“SIPP”) provided by UK-regulated pension trustees for clients who want to save for their retirement by taking advantage of potential stock market growth.
Contact us today to find out more.
Disclosures:
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