Aftershocks Part 2: UBS/CS merger staves off failure, but confidence shaken for bank stakeholders = markets now "reaction dependent" and Fed might do so. 4 signs to see first signs the crisis ebbing. Stay OW Tech + Bitcoin. Array ( [cookie] => c4a941-d88dce-1f0df8-dbcb75-3119e6 [current_usage] => 1 [max_usage] => 2 [current_usage_crypto] => 1 [max_usage_crypto] => 2 [lock] => [message] => [error] => [active_member] => 0 [subscriber] => 0 [role] => [visitor_id] => 42299 [reason] => Usage under limits [method] => ) 1 and can accesss 1

In a time of uncertainty, investors are “reaction dependent” and the Fed might do so…

Over the weekend, UBS -4.40%  announced plans to acquire Credit Suisse, in the latest action to contain the widening financial crisis. A total of 4 notable events took place since Friday, all to contain the continuing after-shocks post-SVB (Silicon Valley Bank) failure. At the top of mind is whether the UBS -4.40% /CS combination will contain the crisis and ripples.

• Notable #2: 6 national banks, Fed, BoE, BoC, BoJ, ECB and SNB, introduce USD swap lines to provide dollar funding. And these will be conducted with a frequency of daily (vs weekly).
• Notable #3: On Sat, the Mid-size Bank Coalition of America (MBCA) sent a letter to the FDIC arguing extending insurance to all deposits would halt the exodus of deposits from smaller banks.
• Notable #4 (smaller): Fed Chair Powell and Treasury Secretary Yellen released a joint statement in support of the SNB actions (supporting UBS -4.40% /CS) and proclaiming the US financial system resilient.
• SVB’s failure triggered several dimensions of risk for the financial system.
  – first, a revelation that in the digital age, deposits are not “sticky” and flee with a swipe
  – second, trust for stakeholders as equity holders wiped out and bondholders “haircut”
  – third, credit liquidity was impaired given counterparty + other “hot potatoes” risks
• The UBS -4.40% /CS merger stems the concerns on the third point above. This third point is a biggie though. When financial systems experience liquidity crises, the contagion risks expand, particularly into the real economy. Some are hopeful this merger quells this liquidity fear. Bloomberg (below) notes, Bob Michele, CIO of Fixed Income for JPMorgan Asset Management, says he is hopeful this will be enough to stave off a wider crisis.
• But deposits are now exposed to be far less “sticky” than originally believed and with the added complication of uninsured deposits (>$250k), deposits are shuffling around madly. This is evidenced by the fact that $496 billion of liquidity was tapped in the past week across Repos, Fed discount window, and FHLB borrowings — although much of it was parked at the Fed.
• According to an analysis by USC economist Jiang and others, there are >180 banks with similar fragility of SVB, meaning sizable unrealized losses on securities holdings and resulting risks to uninsured deposits (>$250k). (see link)
• And UBS -4.40% /CS wiped out $17 billion of CS AT1 bonds (additional tier 1) even as equity holders received $2.8 billion. This is the 4th instance of stakeholders (equity/debt) experiencing outright wipeouts/haircuts on top of Silvergate Bank (SI), Silicon Valley Bank (SIVB) and Signature Bank (SBNY) .
• Last week, multiple well-known credit hedge funds reported sizable losses (link) as the surge in rate volatility, plunge in rate and collapse in liquidity created outsized losses from pedestrian positions. This is what a credit liquidity crisis looks like.
• Sure, this is the framework advocated by capitalists and regulators post-GFC, but the unintended consequence is financial institutions seeking “rescue” levels of capital will not find friendly supporters. Stakeholders take a loss even if regulators decide to save depositors.

Does this mean “aftershocks” part 2 will see the crisis worsen dramatically? Not necessarily. There are some positive offsets that can mitigate risks.

• The CS rescue is really a continuum of fallout from the Fed’s aggressive hikes. First, it was Bitcoin/FTX. Then, the pensions in UK. Last week, it was SVB and regional banks. And now, the long-time weakened CS was rescued.
• Reuters reported that bank deposit outflows slowed/stopped and in some cases “reversing” — if correct, it would imply public fears around uninsured deposits are abating. Definitely important to see corroboration
• There are media reports (link) of many regional bank CEOs visiting Warren Buffett in Omaha this weekend. And similar stories of Buffett in contact with the White House. Buffett played a role in calming markets in post-Long Term Capital failure in 1998 including his investment into Salomon Brothers.
• By almost any investor, Buffett is viewed as savvy investor with patient timing and this move would be viewed as “white knight” and likely bolster depositor confidence as well as stakeholders. And no doubt, Buffett would not make any such move without solid assurances from the US government and regulators. Thus, Buffett could be seen as a catalyst for further quelling financial crisis concerns.
• The money pulled from regional banks has gone somewhere and a lot of it ended up in money market funds, which saw $120 billion of inflows in the past week (thru 3/15). This is a staggering surge and the largest since April 2020. If this reflected Thu/Fri last week, we think this figure would be far larger.
• Another “half-full” positive is the continued inflows in Technology stocks and even Bitcoin. Nasdaq has outperformed (S&P 500) 12 consecutive days and as Goldman data shows, Technology stocks saw inflows while ex-Tech, Cyclicals saw outflows. The Tech vs non-Tech shows that investors could be de-risking rate sensitivity, particularly Financials, but this does not mean that recessionary trades are being added. Technology is not defensive, but it is more attractive if rates are falling.
• Technology is our #1 sector pick (see our 2023 Outlook from early Dec) and at that time, we argued Technology should lead and FAANG could rise as much as +40% in 2023.
• FAANG is up +24% YTD, so tracking to our +40% and Technology is the only positive sector YTD, gaining +8%.
• Bitcoin is up +62% YTD and speaks to its outright resiliency. 3 major onramps for Bitcoin were shutdown in the past few months — FTX, Silvergate’s SEN network and now Signature Bank. And despite this, Bitcoin is seeing accelerated gains. If this does not speak to the protocols resilience, I am not sure what does.
• In fact, a well known Bitcoiner Balaji Srinivasan @balaji (link) bet $1 million that hyperinflation could take place within the next 90 days and see Bitcoin >$1 million. He has placed an actual $1 million bet with James Medlock.
• While investors might want a “bazooka” from the Fed/Treasury ala TARP/GFC, this financial crisis doesn’t have to boil into a solvency episode requiring such tools. And this coming Wed, the Fed will make its rate decision. This itself could act as a market catalyst.

BOTTOM LINE: 4 signs to see first signs the crisis ebbing

In our discussions with hedge funds and clients Sunday evening, we get the sense that investors are being patient. They want to see how markets react to these multiple actions over the weekend. The Fed will likely do so.

• This means stocks are buffetted by these aftershocks.
• What are signs this crisis might be ebbing?
  – MOVE Index (bond volatility) below 150 (180 now) and hopefully settles below 125
  – VIX Index falls below 20
  – First Republic (FRC) comes to a resolution
  – Regional bank deposits stabilize (Tables 9 and 10 of Fed’s H8).
• But we think it is important to take cues from Technology and Bitcoin. These are showing strength, outright, at a time of market turmoil.
• Technology remains our #1 sector pick.

SECTORS: Technology + Bitcoin

Defensives are not leading YTD. In fact, Staples, Utes and Healthcare are among the worst. The leaders are:

• FAANG +24%
• Tech +8%

And data from EPFR/Goldman Sachs shows inflows into Tech steadily. This is a good sign and shows outright support from investors and not short covering.

This is pretty eye opening that Balaji expects hyperinflation to ensue within the next 90 days. This is in response to a bet offered by James Medlock.

CREDIT CRISIS: Hopefully UBS -4.40% -CS quells nerves

Many investors are “reaction dependent” and will see how markets respond to this latest merger. There are some who are hopeful this contains the crisis, as noted by Michele.

And the response by Central banks and by Treasury Sec Yellen/Fed Chair Powell are below.

And this Reuters article is actually encouraging if correct. The leaking of deposits away from banks is one of the 3 prongs of the crisis.

And Buffett as we noted above, would be a White Knight in this scenario. He has a lot of credibility with the public and with investors.

A rescue of First Republic would be important. S&P downgraded FRC again. We view this move as indulgent, since FRC is already below investment grade. Fortunately, there are many working on a solution for FRC as well.

REGIONAL BANKS: Fund flows show large borrowings but also liquidity raising

Below is a summary of bank funding activities over the past week and as shown, $496 billion was borrowed across FHLB, Repos, Fed discount window, BTFP:

• ICI Money Market funds +$121 billion

• FHLB +$161 billion
• Repo +170
• Fed discount window +153 (all-time high)
• Fed’s new BTFP +12
• Total borrowings +$496 billion

This is a lot of increasing in liquidity demands, or more likely, a lot of money shuffling around. A few things stand out:

• First, there is a surprising little use of BTFP at $12b, or ~2% of funding, and with favorable funding terms. As Praveen Korapaty of Goldman Sachs Rates Research notes, this could be due to: (i) stigma of using BTFP, (ii) discount window has wider collateral accepted or (iii) it is too new.
• Second, Praveen notes banks raised funding in access of “lost deposits” evidenced by the fact that H.4 Reserve balances at Fed rose by $441 billion.
• And it looks like $161 billion of deposits might have moved money markets as well.
• As the chart below shows, the flows into money markets overall, including retail is the largest since April 2020. That gives one a better sense of positioning. Risk-off is the message.
• And when conditions change, this will be risk-on.

CALENDAR: Key incoming data starting March 19

The big event this week is FOMC. That is the only real macro data point:

• 3/7 10 am ET Powell testifies Senate Hawish
• 3/8 10am ET Powell testifies House Neutral
• 3/8 10am ET JOLTS Job Openings (Jan) Semi-strong
• 3/8 2pm ET Fed releases Beige Book Soft
• 3/10 8:30am ET Feb employment report Soft
• 3/13 Feb NY Fed survey inflation exp. Soft
• 3/14 6am ET NFIB Feb small biz survey Soft

• 3/14 8:30am ET CPI Feb Tame
• 3/15 8:30am ET PPI Feb Tame
• 3/17 10am ET U. Mich. March prelim 1-yr inflation BIG DROP
• 3/22 2pm ET March FOMC rate decision
• 3/31 8:30am ET PCE Feb

We publish on a 3-day a week schedule:

Monday
SKIP TUESDAY
Wednesday
SKIP THURSDAY
Friday

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