Market Impact of Credit Suisse Deal
Swiss regulators and policymakers responded over the weekend to concerns about a run on deposits at Credit Suisse Group by engineering a sale to UBS Group. We take a closer look at what the deal, and steps central banks globally have taken to address market stress, mean to investors.
What Happened at Credit Suisse?
There are no indications that Credit Suisse has direct exposure to Silicon Valley Bank’s issues, but rather it was a bank that was struggling for years. Its perceived weakness was enough to trigger a bank run. We believe it’s positive to see policymakers step in decisively to remove such a significant risk, but that doesn’t mean the risk to financial stability has been removed completely. We think restoring stability will take time, and perhaps policymakers need to take even more measures.
We see two important implications of the sale of Credit Suisse to UBS:
- The risk of a potential uncontrolled failure of Credit Suisse has been removed. We believe that is a positive development because accelerating deposit outflows at Credit Suisse elevated the risk of contagion to other banks.
- Investors will lose all value from $17 billion worth of Credit Suisse “additional tier 1,” or AT1, bonds, according to the Wall Street Journal. AT1 bonds are securities that look like bonds of a bank until the bank gets in financial trouble, at which point they become worthless. This decision may be right from a technical and financial point of view, but it does introduce new worries around who holds those bonds and what the fallout will be for the broader $275 billion AT1 bond market. We think this is a negative development at a time of high uncertainty.
What Did Central Banks Do?
The Federal Reserve, European Central Bank, Bank of England, Swiss National Bank, Bank of Canada and Bank of Japan announced in a joint statement on Sunday they have taken measures to improve global access to dollar liquidity. They will switch from weekly to daily auctions “to ease strains in global funding markets” until at least the end of April.
We think this commitment from the central banks improves U.S. dollar price discovery, and removes another potential risk of a liquidity freeze. We believe this will improve financial stability, though with no guarantees it will be enough.
Two Potential Future Scenarios
We see two primary scenarios for how these events may impact markets:
- The upside scenario is that price discovery (buyers and sellers are able to agree on pricing of securities, in particular in the AT1 market) works well, allowing tensions to fall and market operations to normalize over time. We think that could take days if not weeks, but in the absence of other bank runs we believe stability will be restored. This is our base case scenario.
- The downside scenario is more potential bank runs, either because of the AT1 losses or some other trigger. In this scenario policymakers will have to take aggressive action to restore financial stability. This is our risk scenario.
How We’re Approaching Investments
We are closely monitoring the situation, paying attention to how markets are behaving and how liquidity is improving or deteriorating, identifying any pressure points and reviewing how policymakers are addressing the issues. Our current positioning remains neutral to risk and close to the strategic benchmark. Our conclusion from last week that the market is expressing too much economic pessimism with the fall in interest rates stands; we continue to caution against overreacting to short-term market movements during periods of excessive volatility.
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