Terms Of UBS Acquisition Wipes Out Additional Tier 1 Capital And Spurs Fresh Concerns

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Overview: UBS's takeover of Credit Suisse, the sale of Signature bank assets, and the daily dollar swaps could have helped stabilize the budding banking crisis. However, the wipeout of the additional tier 1 capital cushion (16 bln Swiss francs) at Credit Suisse has raised concern about the vulnerability of other such assets, which post-GFC is a $275 bln market in Europe. Asia Pacific equities were a sea of red, led by a 2.65% drop in the Hang Seng and a 2.2% fall in its index of mainland shares. Japan and Australia's indices shed more than 1%. Europe's Stoxx 600 is off fractionally, but the bank index is off 2.5% (after a 2.7% sell-off before the weekend). 

Benchmark 10-year bond yields are most 7-9 bp in Europe and the US. Ten-year yields were off 15-16 bp in Australia and New Zealand. The 10-year JGB yield is near 0.20%, down almost eight basis points today. The 10-year US Treasury yield is around 3.34%, while the two-year yield is off nine basis points to about 3.75%. The dollar is mixed. The Scandia and Antipodeans, along with the Swiss franc are nursing modest losses, while the yen leads the advancers with a 0.5% gain, followed by the sterling, which is enjoying a firmer bias. The Dollar Index remains within the range seen last Wednesday (~103.45-105.10) but is at the lower end. Gold punched through $2000 an ounce but has come back offered and is near $1984 in the European morning. May WTI continues the sell-off that began earlier this month from near $81. Today is traded at almost $64.35.
 

Asia Pacific 

The PBOC cut reserve requires 0.25% before the weekend (effective March 27). It will free up around CNY500 bln (~$72.7 bln). Average reserves will be 7.6%, according to the PBOC, down from 15% in 2018. The series of reserve ratio cuts have freed up more than CNY11 trillion. However, officials are still reluctant to sanction rate cuts. Last week, the rate of the benchmark one-year medium-term lending rate was kept steady at 2.85%. Today, the banks, left the loan primes rates unchanged at 3.65% and 4.30% for the one-year and five-year loans, respectively. Meanwhile, a sharp drop in the 10-year Treasury yield has seen the American premium fall to less than 50 bp from 115 bp at the start of the month.

The Topix bank index crashed from a nearly eight-year high on March 9 to a three-month low a week later. It stabilized at the end of last week, but the selling pressure resumed today, knocking it down almost 1.9%. The technicals look poor. A weekly key reversal in the first full week of March was followed by a gap lower open to start last week. While Japanese banks, from a high level, Japanese banks have large holdings of long-term bonds (domestic and foreign) but appear to have offsetting assets that have increased in value, and their deposit bases seem sticky. Japan has a positively slowed yield curve. Its two-year yield is around minus 8 bp. The 2-10-year yield curve was the steepest in almost eight years in mid-February, a little above 55 bp. It fell to almost 30 bp last week before stabilizing.

Falling US rates have dragged the greenback lower against the Japanese yen. It fell to about JPY130.55 today, the lowest level in a little more than a month. Oversold intraday momentum indicators helped the dollar find a bid in early European turnover. The JPY131.50-70 area offers initial resistance now. There were $1.6 bln in options expiring today at JPY131.00 and position-adjusted may have contributed to the losses when it was taken out. The Australian dollar reached a nine-day high slightly above $0.6740 (~A$570 mln in options expire today at $0.6730), before the sellers emerged and knocked it back to $0.6670. Support is seen in the $0.6640-60 area. The Chinese yuan opened firmer, but the weakened as the session progressed. The US dollar retested the CNY6.90 area and is consolidating below it. The PBOC set the dollar's reference rate at CNY6.8694. The median forecast in Bloomberg's survey was CNY6.8708.
 

Europe

UBS's acquisition of Credit Suisse (~$3.25 bln or about 50% less than the pre-weekend equity price implied), with the SNB's CHF100 bln (~12.5% of Switzerland's GDP) liquidity line, is the beginning of the closure of a situation that has been festering for months. The government will also absorb CHF9 bln of potential losses. The deal is not subject to shareholder approval and CS tier one capital--AT1--(~CHF16 bln) is wiped out as taxpayers’ money is used. The combined assets of the two banks are about 2x GDP. By way of comparison, the assets of the top two banks in the US are worth a little more than 25% of the GDP. Building on the principle that supervisory and lender-of-last-resort is fundamentally different from the conduct of monetary policy proper to smooth the business cycle, the Swiss National Bank is likely to hike its deposit rate by 50 bp on Thursday.

The losses on the AT1 bonds spurred contagion among other banks' AT1 assets. Until now, the largest loss suffered was 1.35 bln by Banco Popular in 2017. These assets are meant to absorb losses and holders are paid a premium during "normal" times but are subject to losses. Since the Great Financial Crisis, AT1 assets have become a $275 bln market. The Stoxx bank index gapped lower today and plunged 6.6% before recovering. In late morning turnover, it filled the gap and stalled, off about 2.5%. 

The euro initially extended its pre-weekend gains to above $1.07 on the UBS/Credit Suisse story. However, as concerns about the AT1 asset class rose, the euro came off and fell to around $1.0630 by early European activity. Initial resistance is seen near $1.0670. Still, the euro remains confined to the range seen last Wednesday (~$1.0515-$1.0760). Sterling is faring better. It reached its highest level since mid-February (~$1.2230) and is straddling the $1.2200 area in European turnover. Support now is seen around $1.2160-70. This week's big events lie ahead: CPI on Wednesday and the BOE on Thursday. The swaps market has slightly less than 12 bp of a hike discounted, down from 17 bp a week ago and 24 bp two weeks ago.
 

America

The Fed funds market is pricing in about a 55% chance of a 25 bp hike this week. On March 8, the market had a little more than a 70% chance of a half-point move being discounted. A 25 bp move would bring the upper end of the Fed funds to range to 5.00% and it is seen as the terminal rate. The rate hike may not be the most important part of this week's Fed decision. Although the expansion of the Fed's balance sheet last week from collateralized loans (lender-of-last-resort) rather than bond purchases (quantitative easing), many look for the Fed to slow or end the process of allowing Treasuries and Agencies to mature and not replace them. In addition, the Fed will update its Summary of Economic Projections (dot plot), which has also become an important signaling tool. Financial stress/crisis is a deflationary shock. Some estimates put the equivalent Fed tightening as high as 150 bp. Meanwhile, market measures of inflation expectations have collapsed. The 10-year US breakeven has fallen from nearly 2.55% on March 3 to below 2.10% before the weekend, the lowest since Feb 2021. 

The Federal Reserve announced a boost in the frequency of its dollar swap operations with other major central banks (Bank of Canada, Bank of England, European Central Bank, the Bank of Japan, and the Swiss National Bank). The swap facility was for seven-day operations and was conducted weekly. The seven-day facility will now be offered daily, at least until the end of April. Some pundits paint it with a broad brush and call it a bailout, but it is no such thing. It is part of the new understanding among central banks that it is not so much the price of the dollars that can be disruptive but access. This is partly why was no need for "old-fashioned" coordinated intervention during the Great Financial Crisis or during Covid. 

The US dollar is trading within its pre-weekend range against the Canadian dollar (~CAD1.3680-CAD1.3775) and it continues to chop within the range set last Wednesday (~CAD1.3660-CAD1.3815). So far, today is the third session that the US dollar is recording lower highs. There are options for $640 mln at CAD1.3750 that expire today. The 20-day moving average comes in near CAD1.3675, and the greenback has not traded below it since February 16. The US dollar began trading with a heavier bias and the Mexican peso opened firmer. However, the lingering banking woes saw the US dollar climb and take out last week's highs (almost MXN19.18) and rise slightly through MXN19.23. The upper Bollinger Band is near MXN19.0950, and the US dollar eased to MXN19.00 in early European turnover. It is consolidating below MXN19.10 in Europe. The JP Morgan Emerging Market Currency Index fell 1.1% last week, its fifth weekly decline in the past seven weeks. It is off about 0.25% today and is near this year's low.


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Read more by Marc on his site Marc to Market.

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