U.S. INTEREST RATE markets steadied on March 16 as the Federal Reserve organised major national banks to help boost confidence in their smaller regional counterparts by placing large-scale deposits with First Republic bank. Rate forecasts firmed slightly. But the rate trajectory implied by futures prices still shows rates declining from August onwards as the central bank responds to tightening credit conditions and a slowing economy:
NORTHWEST EUROPE is roughly 85% of the way through the heating season. Temperatures at Frankfurt in Germany have been close to the long-term seasonal average since the start of March. But very warm temperatures in October and from mid-December to mid-January have left a significant deficit in heating demand that has not been erased. The total number of degree days so far this winter (1540) is -16% below the long-term average (1842):
OIL PRICES fell sharply on March 15 in response to growing fears about a banking crisis and its impact on the economy. Brent futures were pushed bellow the bottom of the recent trading range:
U.S. DISTILLATE fuel oil inventories amounted to 120 million barrels on March 10. Inventories were -13 million barrels (-10% or -0.81 standard deviations) below the prior ten-year average. But the deficit has narrowed from -21 million barrels (-16% or -1.62 standard deviations) at the start of 2023 and -31 million barrels (-22% or -2.05 standard deviations) on October 7, 2022:
BANK FAILURES – In March 2008, I was working as an analyst on the trading floor at a commodity firm. The Reuters terminal flashed an alert that the Federal Reserve Bank of New York (FRBNY) had extended a multi-billion dollar credit facility to the troubled investment bank Bear Stearns. As part of my market-monitoring role, I sent a brief one-paragraph email to the treasury and credit teams highlighting the news and warning it probably meant the end for Bear as an independent institution; emergency borrowing from the central bank normally marks effective failure.
Less than five minutes later, the finance director sent an email to all staff instructing no new positions were to be initiated with Bear; only risk-reducing trades that reduced our exposure were permitted. For the next week, our firm would not initiate any new trades unless we could verify Bear was NOT the counterparty. Presumably similar emails and trading prohibitions were being implemented at all the other firms in the market. Bear was isolated, unable to attract cash inflows, and collapsed a week later.
Watching the demise of a major investment bank taught me a valuable lesson: financial institutions live or die by confidence, and once it has been damaged, the end can come extraordinarily fast. Financial institutions die slowly at first, but very quickly towards the end. They do not get the benefit of the doubt. Our firm started to cut our exposure to Bear immediately at the hint of trouble, we couldn’t afford to wait for more information to see if the bank might survive. No one wants to be one of the last counterparties.
Friday is a particularly dangerous day for a bank in trouble. Regulators like to close a bank on Friday so they have the weekend to put in place a resolution and attempt to stabilise confidence in the rest of the financial system by Monday.
U.S. INTEREST RATE traders no longer expect the central bank to lift rates further following the failure of Silicon Valley Bank, with overnight rates expected to start falling from July onwards, as credit conditions tighten and force a slowdown in the economy. The path for interest rates over the rest of 2023/24 is now forecast to be much lower.
But the outcome of a financial failure is notoriously difficult to predict since it depends largely on confidence. Some failures are resolved quickly with little or no impact on the rest of the financial system and the real economy. In other cases, contagion occurs and the economic impact is significant:
EUROPE’s gas storage sites are 56.5% full, the second-highest on record for the time of year, well above the prior ten-year seasonal average of 36.3%. The end of the winter heating and inventory depletion season is now very near (with stocks usually hitting a minimum on March 30 ± 14 days):
U.S. INTEREST RATE traders have slashed exectations for future rate rises as the banking system comes under strain. Banks are heavily engaged in maturity and liquidity transformation, funding longer-term loans with shorter-term deposits and other borrowing. The progressive inversion of the yield curve is putting that function under increasing strain. Silicon Valley Bank (SVB), which failed on March 10 after a run by depositors, may have been an outlier. But the intensifying inversion poses challenges for all banks. Following the run on SVB, traders increasingly think concerns about financial stability will constrain future interest rate increases. Futures prices imply benchmark overnight interbank rates will end the year at around 4.50% (the same level as now) rather than 5.50-5.75% (which was expected as recently as March 8):
U.S. DRILLING activity continues to slow. The combined oil and gas rig count fell by -3 in the seven days to March 10. The total number of active rigs has fallen in 9 of the last 14 weeks by a total of -38 rigs (-5%) since early December:
HEDGE FUND and other money manager positions in the six major petroleum futures and options contracts on February 21, 2023: