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):
Yemen’s decaying oil storage tanker to be unloaded
U.S. TREAURY YIELD curve between two-year and ten-year maturities has inverted to around 100 basis points, the most extreme since August 1981, when the economy was entering the second part of the double-dip recession of the early 1980s. The inversion is signalling a sharp fall in interest rates, resulting from a rapid deceleration of inflation, a downturn in the business cycle, or a combination of both:
U.S. GAS INVENTORIES are moving into an increasing surplus, keeping downward pressure on prices. Stocks were +240 billion cubic feet (+13% or +0.58 standard deviations) above the prior ten-year seasonal average on March 3, up from a deficit of -263 billion cubic feet (-8% or -0.98 standard deviations) on January 1, 2023, and a deficit of -427 billion cubic feet (-13% or -1.52 standard deviations) on September 9, 2022:
U.S. PETROLEUM INVENTORIES including the strategic reserve increased by +2 million barrels over the seven days ending on March 3. Stocks have increased in 10 of the last 14 weeks by a total of +31 million barrels from their recent low on November 25, 2022, arresting the previous downward trend. Inventories are still -231 million barrels (-12% or -2.15 standard deviations) below the prior ten-year seasonal average. But the deficit has narrowed from -278 million barrels (-15% or -3.05 standard deviations) in November:
U.S. INTEREST RATE traders continue to boost their expectations for benchmark short rates at the end of the year as the central bank signals rates may have to go higher and stay there for longer to bring inflation back to target. Rates are now expected to be around 5.25-5.50% in December 2023 up from an expectation of 4.25-4.50% at the start of February:
COMMITMENT OF TRADERS reports – the U.S. Commodity Futures Trading Commission (CFTC) and ICE Futures Europe suspended publication of their commitments of traders reports in late January following a ransomware attack on a major market participant and infrastructure provider which resulted in incomplete submissions. Both are now starting to catch up with the backlog of missed weekly reports. ICE has caught up; the CFTC is still some weeks behind. I am not going to publish a weekly analysis again until they have both caught up fully since the reports now contain very out of date information. For reference, however, the hedge fund and money manager positions on February 7, the most recent currently available, are shown below:
NORTH INDIA has experienced above-normal seasonal temperatures since early February, driving an increase in air-conditioning and refrigeration demand and boosting electricity consumption to a record level. Temperatures in New Delhi’s Palam suburb have been above the long-term seasonal average for 18 out of 22 days since February 9:
U.S. GAS INVENTORIES are depleting much more slowly than normal for the time of year. As a result, inventories were +209 billion cubic feet (+11% or +0.55 standard deviations) above the prior ten-year seasonal average on February 24 up from a deficit of -427 billion cubic feet (-13% or -1.52 standard deviations) on September 9, 2022:
U.S. PETROLEUM INVENTORIES including the strategic reserve rose by +3 million barrels over the seven days ending on February 17. Increased inventories of commercial crude (+8 million), distillate fuel oil (+3 million) and jet fuel (+1 million) were partly offset by reductions in gasoline (-2 million), propane (-3 million) and other oils (-3 million).
Petroleum inventories have risen for seven consecutive weeks by a total of +55 million barrels, the largest increase over any similar period since June 2020, when the market was absorbing the impact of the first wave of the pandemic and lockdowns.
Total inventories are still at the lowest seasonal level since 2005 and -235 million barrels (-13% or -2.22 standard deviations) below the prior ten-year average, but the deficit has narrowed from -291 million barrels (-16% or -3.06 standard deviations) on December 30:
¹ Freeport LNG suffered a catastrophic failure after multiple safety systems failed and personnel ignored warning signs and lost situational awareness about the state of the plant. The resulting explosion is a classic example of what James Reason called an “organisational accident” – multiple systems should have prevented an incident but they were allowed to erode because of a poor internal safety culture leading to a rapid increase in risk (“Managing the risks of organisational accidents”, Reason, 1997).
Reason’s book is one of the best I have read on any topic, offering powerful insights in an engaging and accessible way. He provides a general framework for understanding why many catastrophic industrial and transportation failures happen. Everyone operating critical systems and machinery should be required to read it as part of their training. I can strongly recommend it to everyone else who is interested in safety, reliability and resilience systems.
U.S. OIL AND GAS drilling rates have stalled in response to the slump in prices since the third quarter of 2022. There has been no net increase in the number of active rigs (760) for the last 31 weeks:
EUROPE’s gas futures prices for deliveries in March 2023 have fallen below €50 per megawatt-hour for the first time since December 2021, before Russia’s invasion of Ukraine. Prices have fallen from €177 at the beginning of the winter heating season at the start of October and a record €338 in late August. Energy-intensive industrial closures, conservation measures, the impact of previous high prices, reduced LNG purchasing from China and South Asia, and a mild winter in northwest Europe all combined to avert feared shortages or a price spike during winter 2022/23:
U.S. PETROLEUM INVENTORIES including the strategic reserve surged by +19 million barrels in the seven days ending on February 10. There was a huge accumulation in reported stocks of crude (+16 million barrels) with smaller increases in gasoline (+2 million) and jet fuel (+1 million) partly offset by a drawdown in distillate fuel oil (-1 million).
Total inventories were still -243 million barrels (-13% or -2.26 standard deviations) below the prior ten-year seasonal average. But stocks have been trending higher since late December and the deficit to the seasonal average is staring to narrow: