Juggling Dynamite

Danielle was a guest with Dennis Mitchell and Hillary Johnstone on the CBC Weekend Business Panel. Here is a direct video link.

Deutsche Bank shares are off more than 10% this morning as credit default swaps on its senior euro debt blow out. Contagion fears are spreading after Credit Suisse’s shot-gun sale last weekend. Other banks are tumbling in sympathy. As shown below courtesy of Blomberg, financial shares have plunged sharply in the last month; see Deutsche Bank Shares Plunge in Renewed Bout of Stress.

In addition to credit unions and a host of private lenders, Canada’s publicly traded financial sector comprises about 180 companies. Along with the most regulated and capitalized big six banks and three insurers, the rest are tier-two lenders and brokers that grew like stinkweed during the 2012-2022 decade of low rates and mindless lending. There are skeletons to be revealed in them closets, to be sure.

The Canadian financial sector ETF (XFN) comprises 40 different finance companies, making up nearly a third of the broad TSX index (which many mutual funds and portfolios mimic). The largest ten holdings by market capitalization are listed below (courtesy of BlackRock). This best-in-class financial basket has fallen about 9% over the last month and more than 20% over the previous 13 months. In the 2000-02 and 2007-09 bear markets, these companies all survived, but the basket of shares lost about half its market value both times. Most present holders (including moms and pops) have no idea how heavily exposed they are to this risk. Sadly, they believe they are conservatively invested.

Below is a worthwhile update on central bank policies and banking stress.

Danielle DiMartino Booth joins David Lin to discuss recent banking issues and the Fed — TDLR. Here is a direct video link.

Danielle’s paper, “Too Small To Not Fail, ” discusses the unfolding banking crisis.

With consumer credit conditions already as tight as the 2008 financial crisis (shown below courtesy of The Daily Shot), yesterday, the US Fed hiked its overnight rate 25 bps to the highest level since September 2007 (4.75 to 5%). After insisting in 2021 that the Fed would not even consider raising rates in 2022, yesterday, Chair Powell reiterated their intention for more monetary tightening through 2023.

With the lion’s share of global commodities and debt transacted in US dollars, the Fed leads the world in monetary policy. Other countries try to follow to support their currencies and maintain paying power against the USD. As shown below, courtesy of Charlie Bilello, only four countries have cut rates. This wrecking ball is global.

So much work, evolution, and sober investment are needed to transition to sustainable societies. I’m relieved to see interest rates back to levels that incentivize saving and rational investment decisions over borrowing, mindless consumption, and reckless speculation. But after twelve years of the latter, the abrupt policy reversal is hitting the masses hard, and the economic and wealth contraction threatens to be fugly.

Two weeks ago, Fed futures markets expected the Fed funds rate to peak above 5.5% by August and hold there through the end of 2023. Today (as shown below), it is pricing a peak by May with 140 bps of cuts between June and December. Even if that happens, as with tightening, easing efforts filter through the economy at a lag of 12 to 24 months.
In the meantime, government bonds see a Fed pause and have been rebounding sharply year to date. This will help to repair unrealized losses on held-to-maturity bond allocations (part of what is driving the recent banking contagion). The mortgage-backed securities purchased when mortgage rates were sub 2 percent may prove tougher losses to solve.