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Graph of the week – An uneasy calm after the storm

Market measures of stress in the US and European banking sectors currently do not show signs of extreme investor concern. Neither the ‘TED spread’ nor the ‘Euro TED spread’ are at particularly high levels. A certain calm has returned to European markets as investors come to terms with the implications of the takeover of Credit Suisse by UBS. In the US, however, valuations of bank stocks have remained under pressure.

The TED spread and Euro TED spread measure the interest rate at which banks lend to each other. It is typically represented by the difference between Libor (the London Interbank Offered Rate) and short-term government bond yields. The higher the spread, the greater the level of wariness among banks. As our graph of the week shows, both these spreads are at subdued levels (see Exhibit 1).

Reassuring words in Europe

Part of the decline came after various authorities (the Single Resolution Board, the European Banking Authority, the European Central Bank (ECB), and the Bank of England) moved quickly on Monday, 20 March, to reassure investors in the European/UK AT1 market.

They confirmed that common equity instruments would be the first ones to absorb any losses in future failures; only after their full use would the writing-down of AT1 bonds[1] be required. The message was that what had occurred with Credit Suisse was particular to Switzerland and did not apply in the eurozone or UK. This has helped to calm the AT1 bank debt market.

In contrast, valuations of smaller US banks have remained under pressure.

Comments by US Treasury Secretary Janet Yellen fuelled a selloff on 22 March, as she ruled out a broad expansion of deposit insurance to protect savers with deposits above USD 250 000 in the near term. The Treasury Secretary said the Biden administration was not considering a move to broaden deposit insurance. This would likely require Congressional approval. Yellen said there could nonetheless be ‘reasoned discussions’ on whether the current limit for insured deposits should be lifted as part of long-term systemic reforms.

Some discord

Yellen’s comments contrasted with those of Jay Powell, chair of the Federal Reserve, who on the same day reassured Americans that their deposits were safe in the wake of measures already implemented by policymakers, including a facility set up by the US central bank to boost liquidity for smaller banks.

Yellen said uninsured deposits above USD 250 000 could be protected only if a failed bank was considered to pose a systemic risk to the financial system, as was the case with Silicon Valley Bank and Signature Bank. Such determination, she said, would occur only on a case-by-case basis.

After an earlier speech by Yellen where she had suggested that the US government was ready to step in for individual banks if necessary, smaller US bank stock valuations had rallied. Those gains have since been reversed.

The debate over extending bank deposit guarantees in the US is likely to continue. Investors continue to worry about potential outflows of deposits from regional banks after the collapse of Silicon Valley Bank.

Rapid resolution, limited impact

The case of Credit Suisse is the first time a global systemically important bank (G-SIB) has failed since the post-GFC regulatory framework was put in place. The resolution was executed rapidly with the sale of the bank to UBS. Provided no further problems emerge in the banking sector, this could draw a line under the situation, at least in Europe.

While the situation remains fluid and uncertain, our baseline outlook sees these strains gradually (though unevenly) fading through the spring, with relatively modest effects on economic activity.

Following the latest rate rises by the US Federal Reserve and the ECB, we expect the central banks to continue to tighten monetary policy as needed to fight stubbornly high inflation.

Recent events are nonetheless likely to weigh on economic growth and could lead central banks to reverse a portion of their recent string of rate rises sooner than markets had anticipated just two weeks ago.

Also read Graph of the week – Volatility in bonds creates opportunities


1 AT1 securities are a form of contingent-convertible bonds. Cocos are a hybrid of bank equity and debt. In good times, they act like relatively high-yield bonds; in bad times, and when trigger points – such as a bank’s capital falling below certain levels relative to assets – are reached, the bonds convert to equity, cutting the bank’s debt and absorbing losses. Source: The Economist


Please note that articles may contain technical language. For this reason, they may not be suitable for readers without professional investment experience. Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients. This document does not constitute investment advice. The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns. Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions). Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.

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