Just a week ago, everything was quiet. And then the main topic in global markets was the rapid failure of US bank Silicon Valley Bank (SVB), which ranked 16th in the US in terms of assets. It is the biggest bankruptcy in the United States since the bankruptcy of Lehman Brothers in September 2008.
The main reason for the collapse of SVB can be called the fastest tightening of monetary policy by the Fed in 40 years, which led to the depreciation of long bonds in the bank’s portfolio, says Mikhail Vasiliev, chief analyst at Sovcombank. Thus, over the past year, the Fed has raised the dollar’s key rate by 0.25% to 4.75% to combat high inflation. Additionally, the Fed is shrinking its balance sheet by $95 billion a month, removing excess dollar liquidity from the market.
SVB Bank’s interest rate risk was uninsured, large depositors decided to quickly withdraw their deposits, and the Fed did not bail out this bank. After SVB, another New York bank, Signature Bank, quickly closed.
The European financial sector is closely tied to the United States, so Europe could be hit harder by problems in the US financial sector. “The modern financial system is built on the trust of market players. Today, trust in the global financial system has fallen, and as a result many players in the system are in trouble,” Vasilyev notes. As a result, this week we are seeing a sharp decline in European bank stocks, and shares of Swiss bank Credit Suisse are updating all-time lows.
How are banks and central banks reacting?
Also, European banks, which hold a large share of European bonds, could be signaled by the tightening of monetary policy by the ECB. On Thursday, the ECB, despite the tension on the European financial market, continued the planned increase in the key rate: it rose from 3 to 3.5% per year. The ECB is also struggling with high inflation in the Eurozone. In addition, from March 1, the ECB began to reduce its balance sheet by 15 billion euros per month. The ECB underlined that it was closely monitoring the current tensions in the markets and that it was ready to react if necessary to maintain price stability and financial stability in the euro zone.
In other words, while regulators prefer to speak of what is happening as isolated cases, noting the stability of the American and European banking sector and the large reserves of capital and liquidity of the banks, which have been built up taking into account the lessons of the 2008 crisis. “It probably is. So far, it ‘pierces’ the weakest links in the system. Nevertheless, all crises started with weak links. (as the crisis showed of 2008),” says Olga Belenkaya, Head of Macroeconomic Analysis. Department of FG Finam.
The European financial sector is closely linked to the American sector, so the Old World suffers from problems in the United States in the first place
From an economic point of view, it is dangerous because banks during the financial crisis are struggling for survival and are deprived of the possibility of lending to businesses and the population, which causes a strong recession in the real sector of l economy, notes the expert. “Therefore, the sooner regulators eliminate the foundations for a crisis of confidence, the better. And regulators, remembering the sad experience of the impact of the collapse of Lehman Brothers on the development of the crisis 2008 World Cup, are well aware of this under a reliable guarantee at face value, preventing its uncontrolled sale ‘on the market’ with the threat of an uncontrolled decline in value,” says Belenkaya.
Credit Suisse also requested support from the Swiss National Bank and received a statement in response that it was ready to provide liquidity if needed. The Swiss bank has already announced its intention to access a credit line from the Swiss National Bank of up to $54 billion to boost its liquidity. According to Reuters, the ECB is asking European banks about the extent of their connection to Credit Suisse’s activities in order to better understand the extent of the possible spread of the problems and, if necessary, to develop mechanisms to stop them.
Will there be a new global crisis
However, according to Vasiliev, it is quite possible to expect a further worsening of the situation in the American and financial global financial system. According to him, the probability of a financial crisis is high.
“The Fed missed the moment to fight inflation and is now trying to quickly raise the rate. However, it is now very likely that the economy will have to plunge into recession to defeat inflation. A failure of the financial system puts the Fed in a very difficult situation,” Vasilyev said.
On the one hand, the American Central Bank must fight against inflation, raise the rate further and tighten financial conditions. As early as Tuesday, March 7, Fed Chairman Jerome Powell sent harsh signals to the market and set the stage for raising the dollar’s key rate at the next meeting on March 22 by 0.5 percentage points, at 5.25%. Midway through last week, the market was pricing in the Fed’s record rate of 5.75% in June and expected no rate cuts this year.
The longer the U.S. central bank raises the key dollar rate and continues to hold it at the highest level, the higher the likelihood of a financial crisis and global recession, says Vasiliev. Thus, in 2008, the US economy could not support the Fed rate of 5.25% and the global financial crisis broke out. The global economy has increased its debt significantly since 2020 to overcome the effects of the covid pandemic. Therefore, a sharp tightening of financial conditions could lead to another financial crisis and a Fed rate cut, the analyst admits.
“If the Fed turns to easing monetary policy (out of fear of a recession or because of financial system disruption) before inflation hits, then the Fed risks repeating the stagflation of the 1970s. , when it took 20 years and the Fed raised the rate to 20%, to defeat entrenched inflation,” Vasiliev adds.
On the other hand, the Fed is forced to bail out the financial system and ease financial conditions. After the problems with US banks, the market has significantly reduced its expectations for the path of Fed rates. Thus, market participants estimate that the Fed next week at a meeting on March 22 will raise the dollar’s key rate for the last time by 0.25 percentage points, to 5%, which will complete the tightening cycle. monetary policy. At the same time, the market began laying the groundwork for the start of the Fed’s rate cut cycle as early as July with a target of 4.25% by the end of this year to maintain financial stability and mitigate headwinds. consequences of a probable recession.
“The effects on the US financial market can be mitigated by swift concerted action by the Fed, the US government and other European regulators. If inflation in the US and Europe remains high in the coming months and slows slowly, this will exacerbate the problems in the global financial system. On the contrary, a rapid slowdown in inflation in the United States and Europe will allow the Fed and the ECB to complete the cycle of monetary policy tightening and even to start cutting rates to support the financial system and the economy,” says Vasiliev.
What to expect for Russian banks and economy
According to Vasiliev, there is no direct threat to Russian banks due to the banking crisis in the West. “Due to Western sanctions, the Russian financial system and economy have been largely cut off from the Western financial system. Therefore, a potential new global financial crisis is likely to have less impact on the Russian financial system than the crisis of 2008- 2009.,” he states.
At the same time, a possible financial crisis could lead to a global economic slowdown.
A recession in the global economy should lead to lower commodity prices and lower consumption, the analyst said. American and European consumers will buy less and China will produce less. It is through the channel of raw materials that a possible financial crisis in the West will have a direct impact on the Russian economy and Russian investors, underlines Vasiliev.
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