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FRB’s poor results, including the loss of 100 billion dollars in deposits over the past month, have once again stoked fears for the banking system. Investor nervousness is even greater as bank officers refused to answer analysts’ questions after the results presentation. The market has therefore been left in the dark about the bank’s future, particularly the possibility of finding buyers or shoring up the bank’s activity.
The market obvious took a very dim view of all this, sending FRB’s share price into a tailspin, with fallout spreading to the entire regional bank segment.
Fig. 1 – United States: FRB’s problems are contaminating all regional banks…and undermining market sentiment.
First Republic Bank, share price in dollars KBW Regional Bank Index
The authorities will certainly seek once again to head off any risk of contagion, in order to maintain confidence in the banking sector. The Federal Deposit Insurance Corporation, which is in charge not just of insuring deposits but also overseeing the orderly unwinding of failed banks, is no doubt already at work assessing the bank’s viability.
We will also see the role that big banks will play, including JPMorgan. They had already provided FRB with 30 billion dollars in deposits when the trouble all began.
At this point, we believe that the authorities have all the means to act in restoring confidence rather soon, while dealing with the specific case of FRB.
The Fed is likely to keep its liquidity facilities wide open to the banking sector, regional banks in particular. As we know, this is crucial for keeping liquidity problems from turning into solvency ones.
The Fed’s challenge, which is not operational[H1] , is to make clear that its interventions aim at maintaining financial stability but do not affect its monetary policy strategy in combatting inflation. Indeed, the markets very quickly concluded that the Fed is ready to slow monetary tightening in the event of any problems in the financial sector. This won’t be the case here, if, as we expect, this episode does not trigger any systemic repercussions that would cause economic conditions to worsen markedly.
Even so, as we had suggested, this new episode serves as further notice that the tightening in credit, which is already underway, could get worse. This could also accelerate the transmission of monetary tightening to the real economy.
On the economic activity front, we continue to see signs of resilience in growth. In the US, we have seen in particular how services have held up well and are even strengthening. Falling energy prices have certainly played a role here. In the Eurozone, fiscal stimulus is another factor.
Accordingly, the IFO business climate survey continued to improve in April. In particular, expectations index continued to move back up.
Fig. 2 – Eurozone: Business climate in Germany is improving but is still low.
IFO business climate index– Expectations - current situation, index
Even so, the IFO index remains low, which we believe is consistent with our scenario of weak growth in the Eurozone as a whole, but is still not in recessionary territory.
The downside of this resilience in economic activity is that it could maintain inflationary pressures and make the ECB’s task more challenging.
We still believe that the ECB is approaching the end of its tightening cycle. We expect another two 25-basis point rate hikes. However, the risk for the ECB is that it will have to go even higher than expected if economic activity does not slow down. An even more aggressive move by the ECB would ultimately undermine the growth outlook.
US consumers remain a pillar of economic resilience. Indeed, the figures we now have suggest that consumption increased markedly in the first quarter, thanks mainly to January. GDP growth figures due out tomorrow are likely to show an acceleration of consumption of about 4% in 1Q23 at an annualised pace, up from 1% the previous quarter. This acceleration has been driven by heavy public transfer payments early in the year, which boosted incomes. And by the boost in purchasing power from falling energy prices, no to mention the strength of the job market.
However, consumer confidence does not truly reflect what seems to be a very robust economy. The latest Conference Board Consumer Confidence survey for April shows a slight decline, due mainly to weakening confidence in the outlook.
Fig. 3 – United States: Consumption is holding up, but confidence is still relatively low, particularly in expectations
Conf. Board Consumer Confidence Index Present situation Expectations
As we know, confidence and consumption are only loosely correlated. Even so, it is worth noting that households’ expectations remain lacklustre. In part, this still seems to be due to high inflation. This negative sentiment could end up overwhelming consumer spending attitudes in the coming months, if, as we expect, the job market begins to worsen. For the moment, only a few indices are pointing at a weakening in the job market, including the steady recent rise in jobless claims.
For the moment, as seen in the positive present situation index, households are still very optimistic on the job market, reporting very easy access to jobs.
Fig. 4 – United States: US households are still riding a strong job market
Recessions Gap in “jobs easy to get” and “jobs hard to get”
The coming months will tell us whether or not this solidity lasts. We continue to expect some weakening.