Posted: May 8, 2023
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What to Watch this Week
1. US Jobs Report (May 8th)
- US jobs growth was stronger than expected in April, adding 253,000 non-farm jobs last month.
- The headline payrolls increase was partially offset by downward revisions to the previous two months’ data, but the unemployment rate and wage growth figures also pointed to continuing tightness in the labour market
- The unemployment rate dipped to 3.4 per cent last month, compared with consensus forecasts of 3.6%. Hourly wage growth strengthened 0.5 per cent month on month and was up 4.4% year on year.
- The two-year Treasury yield, which moves with interest rate expectations, jumped to session highs immediately following publication of the data. It was up 0.15 percentage points on the day at 3.94 per cent.
- All eyes are on inflation data on Wednesday to see if the Fed will be put in a tough position after signalling that it may pause rate hikes.
2. US Loan Data – Senior Loan Officer Opinion Survey on Bank Lending Practices (to watch for credit tightening) (May 8th)
3. Biden’s Meeting with Congressional Leaders – Debt Ceiling Meeting (May 9th)
4. US Inflation Data (May 10th)
- The latest US consumer price index report will be released by the Bureau of Labor Statistics on Wednesday (May 10th, 2023). This is expected to show headline consumer price inflation at annual rate of 5% in April (same as in March)
- The rate has been dropping every month since hitting 9.1 per cent in June last year.
- Core CPI, which strips out the volatile food and energy sectors, is expected at 5.4 per cent year over year in April, down slightly from the prior month’s rate of 5.6 per cent.
- While price rises in core services — a category which includes costs related to rent and transportation — are expected to slow, pushing down the overall core figure, analysts at Barclays argued core goods inflation is expected to be higher, driven especially by the rising price of used cars.
5. China PPI & CPI (May 11th)
6. US PPI & Initial Jobless Claims (May 11th)
7. UK Bank of England rate decision, industrial production and GDP (May 11th)
8. G7 finance minister and central bank governors meet in Japan (May 11th)
Top News Last Week
Pressure Mounts for U.S. Regional Banks Following JPMorgan’s Acquisition of First Republic Bank
Has collapsed since the start of 2023
- Following the acquisition of First Republic Bank by JPMorgan, pressure and fear are still mounting in the U.S. regional banking sector. This comes after the collapse of Silicon Valley Bank, Silvergate Capital Corp and Signature Bank earlier this year.
- Shares of other regional lenders, including PacWest Bancorp, West Alliance Bank and Zions Bank, plunged following the demise of First Republic Bank as the acquisition raised concerns among investors over the financial health and prospects of regional lenders.
- Despite reassurances from PacWest Bancorp that “the bank has not experienced out-of-the-ordinary deposit flows following the sale of First Republic Bank and other news” and that its “cash and available liquidity remains solid and exceeded uninsured deposits”, its share plunged by 60% on Wednesday, (May 3rd, 2023). (Source)
- On Thursday (May 4th, 2023), PacWest Bancorp announced that it is exploring options, including a sale. The bank confirmed that it has been approached by several potential partners and investors, and talks are ongoing. Shares of PacWest plunged 51% on Thursday.
- On Thursday (May 4th, 2023), Western Alliance Bank denied a report by the Financial Times that it has hired advisers to explore its options. The bank claimed that the story “is categorically false in all respects” and that “there is not a single element of the article that is true”. The announcement helped pare losses on Thursday as shares of Western Alliance tumbled 38% after dropping as much as 62% in the same day. (Source)
- On Friday (May 5th, 2023), the U.S. regional-banking stocks had a strong rebound after a bruising week of losses, amid signals that some of the selling has been overdone. PacWest’s shares soared almost 82% on Friday while Alliance Bancorp rose 49%.
- PacWest Bancorp slashes quarterly cash dividend to one cent per common share, down from 25 cents a share (Source)
- What happened?
- Following the fastest U.S. interest rate hike cycle in recent history, the value of bond holdings on the balance sheets of the regional banks took a nosedive, driving unrealised losses to an estimated US$1.84 trillion (Source)
- Consequently, depositors are withdrawing money to seek better returns elsewhere. Cracks have since been showing, especially for smaller lenders with fewer resources to defend themselves
- This comes at a time when troubles are brewing in the commercial real estate sector, with legendary investors like Charlie Munger warning that the U.S. banks are packed with “bad loans” that will be vulnerable as “bad times come” and property prices fall (Source). Comments come after Berkshire Hathaway sold its shares in U.S. banks and shifted exposure to Japanese trading houses (Itochu Corp, Marubeni Corp, Mitsubishi Corp, Mitsui and Sumitomo Corp)
Source: Visual Capitalist
U.S. Regional Bank Performance (Q1’23):
Source: Financial Times
FED hikes 25 bps Hinting at Possible Halt; ECB hikes 25 bps with no Indication of Pausing
by the U.S. Federal Reserve
Federal Funds Rate
Target Inflation Rate
U.S. Federal Reserve
- On Thursday (May 4th), FED chair Jerome Powell announced the 10th successive interest rate hike since March 2022.
- The Federal Open Market Committee (FOMC) agreed to raise federal funds rates by 25 bps to a new target range of 5% – 5.25%. This comes after major cracks have shown in the US regional banking system as fourth lenders have collapsed since the start of 2023
- Powell’s comments hinted that with interest rates now above 5% and a credit crunch among stressed regional banks likely to further cool the economy, the Fed may have reached a point where it has done enough to decrease inflation towards its 2% target
- Powell acknowledged that in light of bank stress, the Fed need not raise interest rates “quite as high” as they would have in a more stable situation. Some economists fear that Powell may have hinted too strongly that a pause is forthcoming, leaving the Fed exposed to an abrupt change of course if economic data suggests that inflation persist.
by the European Central Bank
Federal Funds Rate
European Central Bank (ECB)
- The European Central Bank delivered the smallest interest-rate hike yet (25 bps) in its battle with persistently strong inflation but insisted that the move won’t be the last
- Deposit rate was raised by a quarter-point to 3.25% on Thursday (May 4th) following 3 hikes of 50 bps
- ECB reiterated its commitment to return inflation to 2% target. Christine Lagarde, ECB president, said, “We have more ground to cover and we are not pausing, that is extremely clear”, but borrowing costs are now in “restrictive territory” and signs of a credit crunch had been a big factor in its decision to slow the pace of rate rises.
- Economists now expect a couple more quarter-point moves by the ECB to lift its deposit rate to 3.75% by July, which would match its highest-ever level in 2001
- In another move intended to increase borrowing costs, the ECB said it expected to buy fewer bonds to replace maturing securities as it seeks to shrink its balance sheet. It expects halt reinvestments under its Asset Purchase Program (APP) as of July.
- The bank has built up huge bond holdings since 2015 and now intends to cut the stockpile by €25bn a month from July, compared with the current pace of €15bn.
- The European Central Bank’s (ECB) Asset Purchase Program (APP) and Pandemic Emergency Purchase Program (PEPP) are initiatives designed to support the economy and maintain financial stability in the Eurozone.
- Launched in 2014, the APP is a long-term plan where the ECB buys financial assets like government bonds from banks and other financial institutions. This helps in increasing the amount of money in the system, making it easier for businesses and consumers to borrow and spend, which boosts the economy. (How does the APP work?)
- By purchasing these assets, the ECB increases the demand for bonds, which in turn raises their prices and lowers their yields (interest rates). Lower bond yields reduce borrowing costs for governments, businesses, and households, stimulating spending and investment, which ultimately helps in achieving the ECB's inflation target
- Cutback effects: Reducing the APP could lead to a decrease in bond prices and an increase in bond yields, potentially making borrowing more expensive. This might slow down spending, investment, and economic growth in the Eurozone.
Hindenburg Research Finds a New Short-sell Target in Activist Investor Carl Icahn
drop in Net Worth following Hindenburg Report
overvalued vs. NAV
- After hitting Indian billionaire Gautam Adani and US fintech company, Block (f.k.a. Square), Hindenburg Research is back at it. The crosshair is on activist investor, Carl Icahn, this time.
- Specifically, short-seller Hindenburg Research accused him of using a “ponzi-like” economic structure at his investment company, Icahn Enterprises (IEP), which is a publicly traded limited partnership that operates as a holding company.
- Carl Icahn’s net worth fell by $10 billion following the release of Hindenburg Research’s report
- Here are some of the key allegations:
- Most closed-end funds trade around, or at a discount, to their NAV. Vehicles run by other managers like Dan Loeb’s Third Point and Bill Ackman’s Pershing Square, trade at discounts of 14% and 35% to NAV, respectively. IEP’s premium to NAV is higher than all 526 US-based closed-end funds
- The reasons for the high premium to NAV are (i) IEP’s attractive dividend yield of ~15..8%, making it the highest dividend yield of any US large cap company (or 50.5% of the last reported NAV), and (ii) the prospect of investing alongside Carl Icahn
- Dividend is unsupported by IEP’s cash flow and investment performance, which has been negative for years. IEP’s investment portfolio lost 53% since 2014, with $4.9 billion of FCF burned over the same period
- Despite its negative financial performance, IEP has raised dividend 3 times since 2014. The most recent increase in 2019 came as IEP recorded FCF of -$1.7 billion in the same year
- Given its investment and operating performance, the company has been forced to support its dividend using regular open market sales of IEP units through at-the-market (ATM) offerings, totaling $1.7 billion since 2019
- IEP’s last reported indicative NAV of $5.6 billion is inflated by at least 22%, owing to a combination of overly aggressive marks on IEP’s less liquid/private investments & continued YTD underperformance
- g., IEP owns 90% of a publicly traded meat packaging business it valued at $243 million at year-end. The company’s market value was $89 at that time. In 2022, IEP bought over a million shares of the company in December before immediately writing up the value of those shares by 194% in the same month
- In January 2020, UBS dropped coverage of IEP following research citing a “lack of transparency” and marks that were “divergent from their public market values”, among other issues
- Beyond aggressive marks, Icahn’s liquid portfolio continued to generate losses…have lost $471 million in value YTD, despite the S&P gaining 9.2% in the same time frame
- IEP is highly levered, with $5.3 billion in Holdco debt and maturities of $1.1 billion, $1.36 billion and $1.35 billion due in 2023, 2025 and 2026 respectively
- Debt covenants do not permit IEP to incur additional indebtedness and is only allowed to refinance old debt. With rates higher, IEP will need to pay significantly higher interest on future refinancings
- Icahn has little ability or reason to bail out IEP with a capital injection, particularly at such elevated unt prices. Further underscoring Icahn’s limited financial flexibility, he has pledged 181.4 million units, or ~60% of his IEP holdings, for personal margin loans. Icahn has not disclosed basics about his margin loans like loan-to-value, maintenance thresholds, principal amount or rates
U.S. Debt Ceiling – Yellen: Default is Possible by June 2023
Debt Ceiling (U.S.)
Meeting between Congressional Leaders
increase in Debt Ceiling Limit proposed by Republicans
- The U.S. government’s deadline to raise the $31.4 trillion debt ceiling could be sooner than expected. US Treasury Secretary, Janet Yellen, warns that the US could default on its debt as soon as June 1st, 2023 if the debt ceiling is not raised before then.
- The cost of insuring against a US treasury / debt default has risen substantially as seen from the US Sovereign credit default swap (CDS). A CDS is a financial contract between two parties where the seller agrees to compensate the other party in the event of a debt default or other credit event.
- Republicans and the White House are having a standoff over the debt ceiling because Republicans aim to use the congressionally mandated federal debt ceiling to exact spending cuts from President Joe Biden and the Democratic-led Senate
- Democrats have rejected outright the House Republicans’ debt-ceiling bill, which would increase government borrowing authority by $1.5 trillion or until March 31, whichever comes first, and cut spending to offset the increase. The White House says House Republicans should just raise the debt ceiling with no conditions, but House Republicans reject that approach and call for an agreement with the White House on budget cuts
- President Joe Biden invited congressional leaders for a May 9th meeting as US inches towards a potential debt default following a stalemate in the negotiations between the White House and Republicans
- Should they reach an impasse, the US federal government would face various unpalatable options, ranging from delaying payments to contractors, social security recipients, Medicare providers or agencies, or even to default on payments on US government debt
- The last time the US was so close to hitting the debt ceiling was in 2011. Even though a deal was eventually struck, four days later Standard & Poor’s, the credit rating agency, stripped the AAA rating from US government debt. The downgrade sent US share prices down more than 5 per cent in a day and exacerbated the deepening eurozone crisis.
- In 2011, the US Treasury had a plan to ensure that the government did not default on its obligations to Treasury bondholders by cutting spending. But this implies huge cuts, which could send the US economy into recession and weigh on global growth.
Banking Job Cuts: Morgan Stanley Announces Second Round of Job Cuts
- Morgan Stanley plans to eliminate another 3,000 job by the end of June, with the investment banking and securities divisions are expected to be more affected than other parts of the bank. Work on initial public offerings and mergers and acquisitions has dried up, as global dealmaking suffered its weakest start to a year in a decade. That leaves institutions that rushed to hire staff to deal with booming activity during the coronavirus pandemic with more people than they need.
- For Morgan Stanley, this will be the second round of cuts in less than six months. It eliminated 1,800 staff in December, or just over 2 per cent of its workforce. At that time the bank said no further reductions were expected.
- Lazard said last week that it planned to reduce its staff by 10 per cent over the course of 2023, citing a continuing deep chill in deal activity and high costs from adding staff during the pandemic. Revenue from its deal advisory business fell 29 per cent in the first quarter from a year ago, according to earnings released on Friday. While asset management fees proved more resilient, overall Lazard reported an unexpected loss of $23mn.
- Citigroup, Bank of America and Wells Fargo have all also culled jobs so far this year, as have law firms, including Kirkland & Ellis, and the Big Four accounting firms.
- Banks including Credit Suisse, Goldman Sachs, Morgan Stanley and Bank of New York Mellon have begun to cut more than 15,000 jobs in recent months
Credit Suisse AT1 Bondholders sues Swiss Regulator FINMA
of AT1 bonds written off
Bondholders have launched legal action
- Credit Suisse AT1 bondholders had ~$1.7 billion of Credit Suisse bonds written down after the bank’s arranged marriage with UBS. (Source)
- Pallas, a law firm representing two groups of Credit Suisse bondholders in Switzerland, said it had filed legal action against Swiss banking regulator, FINMA, on April 18th over an emergency ordinance that prioritised shareholders over AT1 bondholders
- Pallas was instructed to pursue compensation on behalf of ~90 institutional investors and asset mangers holding more than $1.35 billion in AT1 bonds and about 700 retail and family offices holding ~$300 million
- The latest suit means that investors representing up to 1/3 of the $17 billion of AT1 bonds issued by Credit Suisse have now launched legal action.
- It comes after the bondholders were wiped out by the emergency takeover brokered by Swiss regulators in March, while shareholders were handed $3.25bn in UBS shares in an apparent reversal of debt recovery norms.
- A separate group of bondholders, represented by law firm Quinn Emanuel Urquhar & Sullivan, filed their own legal challenge against FINMA last month (Source)
Australia Signals Further Tightening After Unexpected Rate Hike
- Australia’s central bank signaled further policy tightening ahead after unexpectedly raising interest rates by a quarter-percentage point on Tuesday, sending the currency and bond yields surging
- Australian government bonds slid after the decision as the prospect of higher rates curbed demand for government debt. The selloff pushed three-year yields 22 basis points higher, boosting the appeal of the Australian dollar, which strengthened more than 1%. The benchmark share index dropped 1.1% as higher borrowing costs may slow profit growth
- The RBA began hiking aggressively from May 2022 and then pivoted earlier than global counterparts to smaller increases