“Closed-door meetings have been going on all day in DC,” said the CIO Saturday night.“ They’re calling it the billionaire’s bank,” he said. “If this were 2008, there would be no question a deal would get done, but it’s 2023 and the optics are very different,” he said. “Something will get done before the market opens Monday morning. JP Morgan, Goldman, Morgan Stanley, Citi, someone takes this over. 85% probability, perhaps 95%. But if it doesn’t happen, it’ll be for some political reason, and stocks are going to get absolutely slammed.”
Overall: “If the totality of the data were to indicate that faster tightening is warranted, we would be prepared to increase the pace of rate hikes,” said Jay Powell on Tuesday, adding that the ultimate level of interest rates is likely to be higher than previously anticipated. “SVB Financial Group Announces Proposed Offerings of Common Stock and Mandatory Convertible Preferred Stock,” read Silicon Valley Bank’s press release on Wednesday, disclosing a $1.8bln loss in Q1. “Banks Lose Billions in Value After Tech Lender SVB Stumbles,” wrote the WSJ on Thursday. On Friday, the US Treasury issued this statement: “Secretary Yellen expressed full confidence in banking regulators to take appropriate actions in response and noted that the banking system remains resilient, and regulators have effective tools to address this type of event.” So now we know -- Tuesday-to-Friday -- that’s the speed at which we can transition from accelerating rate hikes to cascading crisis in a hyper-financialized economy bumpingup against its inflationary constraints. Despite the guard rails that have been imposed in recent decades to safeguard the financial system, America’s 16th largest commercial bank failed at Terra Luna speed. In an ironic twist, this abrupt breakdown in the legacy financial system spilled over into the crypto economy. The second largest US dollar stablecoin broke the buck, as a portion of its reserves were held at SVP. But Yellen is correct, our regulators have the tools to address any event. In a fiat system, there is no crisis that cannot be tempered through monetary manipulation. And for decades the cost of filling the holes left by our financial fiascoes has appeared small. Because inflation has been low and stable. But this is unambiguously no longer true. And so practically speaking, our policy makers now find themselves with the tools to solve one set of problems, while simultaneously amplifying others; they can thus avert shorter- term financial instability or longer-term inflation, but not both.
I dropped a podcast on Bankless, a really fun discussion where we cover global macro, digital assets, how we navigated these wild markets. Some old war stories too. To listen on Spotify [here], and Apple [here]. To watch on YouTube [here].
Week-in-Review: Mon: ECB’s Holzmann wants 4 more 50bp hikes, China’s NPC announces 5% growth target (lower than exp), Turkey opposition party names Kilicdaroglu as candidate to face Erdogan, Meta to layoff thousands this week, S. Korea CPI 4.8% (5%e), Swiss CPI 3.4% (3.1%e), EU ret sales -2.3% (-1.8%e), EU Investor conf -11.1 (-5.5e), US factory orders -1.6% MoM (-1.8%e), S&P +0.1%; Tues: Fed’s Powell says rates to go higher and maybe faster than market expects (market moves quickly to price 50bp hike at next meeting), RBA hikes 25bp as exp / Lowe says pause is getting closer, BOE’s Mann suggests GBP may weaken further, Biden’s budget to propose hiking tax on those making over $400k / cut deficit by ~$3T, China new foreign min warns US/China conflict risks becoming entrenched, S. Korea 4Q GDP 1.3% (1.4%e), Japan real earnings -4.1% (-3.2%e), Swiss unemp unch at 1.9%, S. Africa 4Q GDP 0.9% (2.2%e), Mexico cons conf 44.8 (44e), US cons credit 14.799b (25b exp), S&P -1.5%; Wed: BoC pauses hikes – 0bps as exp, Powell backpedals by saying Fed is not on a preset path, ECB’s Visco doesn’t appreciate colleagues comments calling for future and prolonged hikes, BoE’s Dhingra favors pausing, Riksbank’s Breman wants a substantial pausing, data shows Japanese investors bought foreign bonds for first time in 14m, PBOC set CNH fixing stronger than exp, Silvergate Bank (focused on providing traditional banking services to crypto companies) to shut down, Japan leading index 96.5 (96.9e), Germany ret sales -4.6% (-5%e), Germany IP -1.6% (-3.7%e), Hungary CPI 25.4% as exp, EU final 4q GDP 1.8% (1.9%e), US mortgage applications 7.4% WoW (-5.9%p), US ADP emp chg 242k (200k exp), US JOLTS job openings 10.824m (10.546m exp), S&P +0.1%; Thu: Silicon Valley Bank leads Financials and broader market sharply lower after sustaining losses in securities sales and deposit withdrawal / prominent VC funds suggested reducing SVB exposure, S&P unexpectedly cut S. Africa to stable from positive, BoJ Gov nominee Ueda approved by Lower House (Upper house tomorrow), Japan final 4Q GDP 0.1% (0.8%e) / Deflator 1.2% (1.1%e), China CPI 1.0% (1.9%e) / PPI -1.4% (-1.3%e), S. Africa CA -2.6% (-2.5%e), Mexico CPI 7.62% (7.68%e) / Core CPI 8.29% (8.35%e), US init claims 211k (195k exp), S&P - 1.9%; Fri: BoJ unch as exp, US NFP 311k (225k exp) / unemp 3.6% (3.4%e) / AHE 4.6% (4.7%e), China president Xi appointed to 3rd term, SVB contagion fears permeate markets / SVB failed to raise capital so is in talks for sale / FDIC takes over SVB, Biden poised to further tighten US Chipmaking exports to China, Erdogan confirms elections to be held May 14th, Japan PPI 8.2% (8.4%e), UK IP -4.3% (-4.1%e), Norway CPI 6.3% (6.8%e) / Core CPI 5.9% (6.3%e), Turkey IP 4.5% (2.1%e), China new loans 1.81T (1.5T exp) / M2 12.9% (12.5%e), India IP 5.2% (5.1%e), Brazil IPCA infl 5.6% (5.53%e), Canada emp chg 21.8k (10k exp) / unemp 5% (5.1%e), Russia CPI 10.99% (11.08%e), S&P -1.5%; Sat/Sun: Weekend talks to scramble for SVIB resolution before markets open Monday.
Weekly Close: S&P 500 -4.5% and VIX +6.31 at +24.80. Nikkei +0.8%, Shanghai - 3.0%, Euro Stoxx -2.3%, Bovespa -0.2%, MSCI World -3.6%, and MSCI Emerging - 3.3%. USD rose +12.3% vs Bitcoin, +11.5% vs Ethereum, +3.1% vs Mexico, +2.9% vs Australia, +2.4% vs Sweden, +1.7% vs Canada, +1.0% vs Indonesia, +1.0% vs South Africa, +0.9% vs Turkey, +0.7% vs Russia, +0.3% vs Brazil, +0.2% vs China, +0.1% vs India, and flat vs Sterling. USD fell -0.9% vs Chile, -0.6% vs Yen, and -0.1% vs Euro. Gold +0.7%, Silver -3.4%, Oil -3.8%, Copper -0.9%, Iron Ore +0.4%, Corn -3.5%. 10yr Breakevens (EU -27bps at 2.40%, US -23bps at 2.29%, JP -5bps at 0.67%, and UK - 7bps at 3.65%). 2yr Notes -27bps at 4.59% and 10yr Notes -25bps at 3.70%. Year-to-Date Equities (high to low): Ireland +17.5% priced in US dollars (+17.9% priced in euros), Czech Republic +16.4% priced in US dollars (+14.5% in koruna), Mexico +15.4% in dollars (+8.9% in pesos), Italy +14.6% in dollars (+15.1% in euros), Greece +13.2% (+13.6%), Spain +12.4% (+12.8%), France +11.1% (+11.5%), Euro Stoxx 50 +11.1% (+11.5%), Germany +10.4% (+10.8%), Austria +9.8% (+10.2%), Taiwan +9.4% (+9.8%), Chile +9.3% (+2.5%), Netherlands +7.4% (+7.8%), NASDAQ +6.4%, Japan +4.9% (+7.9%), Sweden +4.8% (+7.3%), China +4.3% (+4.6%), Denmark +3.8% (+4.3%), UK +3.7% (+4%), Poland +3.3% (+3.7%), Argentina +3.2% (+17%), Korea +2.9% (+7.1%), Hungary +2.2% (-1.6%), MSCI World +2.1% priced in US dollars, Russia +1.9% (+5.7%), Finland +1.3% (+1.7%), Philippines +1.3% (+0.4%), Belgium +0.8% (+1.2%), Switzerland +0.7% (+0.3%), Russell +0.7%, S&P 500 +0.6%, Portugal +0.3% (+0.7%), Canada +0% (+2%), Saudi Arabia +0% (-0.1%), Indonesia -0.9% (-1.2%), New Zealand -1% (+2.2%), South Africa -1.5% (+5.6%), Australia -1.5% (+1.5%), HK -2.9% (-2.3%), India -2.9% (-3.8%), Singapore -3% (-2.3%), Venezuela - 3.2% (+38.9%), Israel -3.4% (-1.4%), Turkey -3.5% (-2.3%), UAE -3.8% (-3.8%), Brazil - 3.9% (-5.6%), Thailand -4.2% (-4.1%), Colombia -5% (-7.7%), Norway -5.3% (+2.1%), Malaysia -6.6% (-4.2%).
S&L Redux: Let’s crisis-skip a generation or two. Policy makers anchor to their most recent experience, and a simplification of longer history. So, when the policy response to the pandemic was clearly excessive in terms of easing, central banks were quick to dust off the old playbooks – talk loudly and wave the rate-hiking stick to keep inflation expectations in check. It seemed to work. The global economy fumbled forward, and market expectations stayed anchored to long-term inflation objectives even as inflation surprised to the upside and remained sticky.
S&L Redux II: But like most history, the good parts are romanticized, and the bad parts are footnotes. Historians like Ken Robinson at the Dallas Fed help bring attention to those footnotes. Robinson is an expert on the 1980s Savings and Loan crisis, and it rhymes most with today. “S&Ls have their origins in the social goal of pursuing homeownership. The first one was established in Pennsylvania in 1831,” Robinson wrote. “These institutions were originally organized by people who wished to buy their own homes but lacked sufficient savings.”
S&L Redux III: S&Ls got their start as the banks for the unbanked. Robinson observes that “the early 1800s, banks did not lend money for residential mortgages. The members of the group would pool their savings and lend them back to a few of the members to finance their home purchases. As the loans were repaid, funds could then be lent to other members.” Fast forward to the 1980s and S&Ls had two problems – the dramatic rise in interest rates made regulated deposit rates less attractive and long-term mortgages lost a lot of value with the surge in yields.
S&L Redux IV: Today, the surge in interest rates to quell inflation has saddled the banking system with $600-$700 billion in unrealized losses. Deposit rates are pinned near zero to protect bank average interest margins. No “stress test” will identify these forces because that’s not what these tests are designed to do – net interest margins are always positive over time because curves are naturally upward sloping. Banks can always grow out of potential market losses - until they can’t. Stress tests were designed to fight the 2008 war - loan losses are not today’s threat.
S&L Redux V: The start of it all, by Robinson’s account, was fiscal policy. Spending programs like the “Great Society” coupled with war-financing drained productive capacity and led to a build of inflationary pressures. Today’s fiscal excess, and untenable projections, dwarf the 1960s. Deregulation was the extend-and-pretend strategy with S&Ls. Many operated as zombies with steeply negative equity. So, S&Ls took even more risk. Eventually, the government’s Resolution Trust Corp shuttered over 1,000 S&Ls over a decade-long workout of that fiasco.
S&L Redux VI: When summoning the Gods of Volcker, don’t forget the law of unintended consequences. S&Ls designed to help people buy homes were transformed into risk-taking junk-bond-making financial-wrecking machines. And it was only through capital destruction that the “all clear” bell rang. The path along the way is strewn with honest intentions of making things better – including an increase in the limit on deposit insurance from $40k to $100k that served to help bad banks attract deposits. Knowing what to do is always easier than doing it.
Anecdote: “Be on the bid when they’re selling. And be the offer when they’re buying.” That’s what they taught us as young pit traders in Chicago. “Don’t have an opinion, those cost you a fortune.” But most of us did anyway. “Know where the orders are, lean on them.” We’d scramble to accumulate long positions just above a big buy order, confident we could sell into that order and get flat, losing little or nothing. And we would build shorts at or just below big sell orders. “You must figure out where the stop-loss orders are, that’s the most important thing to know.” If there was a big stop-loss sell order below the market, and prices seemed soft, everyone would start selling. The closer prices got to the stop, the more aggressively people would sell, hoping to trigger the sell order, which would push prices sharply lower and allow everyone in the pit to cover their shorts at a big profit. Stop loss orders thus exerted a gravitational downward pull on prices. The larger the order, the stronger the force. This principle applies equally on the upside. It sounds rather easy, which it rarely was, but that’s how markets have always worked and always will. Once you know that, it makes sense to spend much of your time discovering where the big stops are. The greatest trades always end with a massive stop loss. Lehman got stopped out. And the consequences were so severe that policy makers generally concluded that such a liquidation could not happen ever again. Or at least not on their watch. Each time prices got too close to a major stop an intervention interrupted the natural course of markets. But everything has its price. The consequences were manifold and included a historic transfer of risk away from the private sector onto public sector, which was better able to insulate itself from market forces, so long as inflation remained low. Which it did, but no longer is. As much as we all might want to believe that our governments and central banks are sufficiently powerful to operate without stop losses, history teaches us that they are not. And the market is starting to send early signals that these stops are building.
Good luck out there,
Chief Investment Officer
One River Asset Management
Disclaimer: All characters and events contained herein are entirely fictional. Even those things that appear based on real people and actual events are products of the author’s imagination. Any similarity is merely coincidental. The numbers are unreliable. The statistics too. Consequently, this message does not contain any investment recommendation, advice, or solicitation of any sort for any product, fund or service. The views expressed are strictly those of the author, even if often times they are not actually views held by the author, or directly contradict those views genuinely held by the author. And the views may certainly differ from those of any firm or person that the author may advise, converse with, or otherwise be associated with. Lastly, any inappropriate language, innuendo or dark humor contained herein is not specifically intended to offend the reader. And besides, nothing could possibly be more offensive than the real-life actions of the inept policy makers, corrupt elected leaders and short, paranoid dictators who infest our little planet. Yet we suffer their indignities every day. Oh yeah, past performance is not indicative of future returns.