Are banking fears starting to ease?

Executive summary:

Market concern over Deutsche Bank is easing
Banking sector turmoil is subsiding in the U.S. and Europe
As banking concerns fade, equities and bond yields are rising

On the latest edition of Market Week in Review, Senior Director and Chief Investment Strategist for North America, Paul Eitelman, and Sophie Antal-Gilbert, Head of AIS Portfolio & Business Consulting, discussed the latest developments in the global banking system, including the recent selloff in Deutsche Bank stock. They also reviewed the market’s reaction to the latest banking sector headlines.

Is the banking situation in the U.S. and Europe stabilising?

Antal-Gilbert and Eitelman opened the segment by unpacking the latest news from the banking sector, which has been under stress ever since the failure of Silicon Valley Bank on 10 March. Noting that there have been no additional bank failures in recent days, Eitelman dubbed the week of 27 March a week of no news. "After the turmoil of the previous two weeks, no news is good news," he remarked. The relative calm was especially welcome after concerns over Deutsche Bank rattled markets at the end of the previous week, Eitelman noted.

He explained that on 23 March, the bank’s credit-default swaps spiked, leading to a sharp selloff in shares of Deutsche Bank the following day. Eitelman said in the aftermath of the plunge, European regulators have zeroed in on a single $5 million trade on a junior credit-default swap as the likely culprit behind the volatility. "This speaks to some of the fragility in the banking system right now, as well as the important role that confidence in banks is playing, given the enormous market scrutiny banks have been under these past few weeks," he explained.

Eitelman noted that Deutsche Bank is a very large, systemically important financial institution that is well capitalised, with very high liquidity coverage ratios. Unlike Credit Suisse, which was acquired by UBS on 20 March, Deutsche Bank was actually quite profitable in 2022, Eitelman said. "This profitability is important, because in periods of stress, it allows the bank to absorb some capital damage through its internal funds," he explained. However, worries over Germany’s largest lender have eased in recent days, Eitelman said, pointing out that the bank’s credit-default swap spreads have compressed back in about 25% of the way.

Switching to developments in the U.S. banking sector, Eitelman said the news appears brighter as well, with the latest numbers suggesting that the pace of deposit outflows has slowed. In addition, on 30 March, the U.S. Federal Reserve (Fed) released weekly numbers on its emergency lending to banks – via its discount window and the Bank Term Funding Program. "Over the last two weeks, there’s been incrementally less usage in these emergency liquidity programs. This suggests that not as many small banks are facing extreme liquidity pressures anymore," Eitelman explained.

Overall, banking conditions appear to have stabilised in both the U.S. and Europe, he concluded, with the caveat that things could still change.

How are markets reacting to the latest banking sector developments?

Eitelman said that markets have reacted positively to the latest developments in the banking system, characterising the week of 27 March as a risk-on week in global financial markets. Broadly speaking, equities and bond yields were up on the week, he stated. Case-in-point: In the U.S., the benchmark S&P 500® Index rose approximately 2% (as of market close on 30 March), while Treasury yields – particularly at the front end of the yield curve – also climbed, Eitelman said.

"The front end of the curve is the most sensitive to expectations around Fed pricing – and as banking fears have eased a bit, investors have started betting that the Fed might not cut rates by the end of the year as much as previously anticipated," he stated.

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Any opinion expressed is that of Russell Investments, is not a statement of fact, is subject to change and does not constitute investment advice.