We entered March 2023 in a relatively optimistic mood as the full year 2022 earnings season had painted a relatively benign outlook for European corporates especially when compared against the more pessimistic scenarios for an inflation induced recession in the coming months. The promise of peak inflation and China’s slow emergence from a Covid inspired lookdown had the potential to stave off or even avoid the worst of a slowdown. Of course central banks had a role to play in this scenario and the ECB’s mid-March meeting looked set to deliver another harsh 50bp increase to rates. But two events were to dramatically change that environment.
First was the threat to the thesis of peak inflation. In Germany for example, the figures for February demonstrated an acceleration in prices compared to the previous month’s year on year increase. The decline in energy prices appeared to be offset by other items notably food and drink, suggesting a more sticky scenario for inflation than had previously been hoped for. The reaction from central banks was to up the hawkish commentary, most notably the US Federal reserve, with Chair Jerome Powell stressing the importance of a data centric policy.
The second event emanated from the, at the time, little known silicon valley lender SVB Financial Group which fell 63% in pre-market trading on the 10th March. Despite attempts at an emergency equity raise to shore up its capital base, the inability of the bank to meet the demands of redemption from its deposit base proved too much and scared off any potential investors. The knock-on effect not only saw precipitous falls for other US regional banks but sent shudders throughout the global financial system with any institutions showing signs of weakness being heavily punished. Despite few signs of contagion appearing in the intervening days, attention did eventually turn to Credit Suisse in Europe, a bank long known to be struggling but now close to the brink. Swift action from both the Swiss authorities and US counterparts appeared to, at least in the short term, go some way to resolving the situation. That said a degree of nervousness lingers with some evidence of deposit flight lingering though, as of the time of writing, conducted in a more orderly manner.
While the financial turmoil did not impact the anticipated 50bp hike from the ECB it did appear to alter the tenor of the forward communication. Gone was reference to further rate increases replaced by a strategy that would be heavily dependent upon the outturn of events. To make such a U-turn in such a short space of time suggested that authorities viewed the potential impact on credit availability to be so severe that inflation could comfortably take a back seat as the lesser of the two evils.