US Banking Turmoil

Last week US authorities stepped in to close the Silicon Valley Bank and guarantee deposits ^[1], while the Federal Reserve announced a new Bank Term Funding Program (BTFP), offering loans of up to one year in length to banks and other institutions. ^[2]

The robust action to contain the fallout offered some respite, but fears over the health of the financial system persisted, with regional banks coming into the spotlight. First Republic Bank was one of those, whose Long-Term Issuer Default Rating (IDR) was downgraded to BB (from A-) by Fitch this week ^[3].

In the latest development though, eleven banks which include heavyweights such as JP Morgan Chase and Citigroup, offered assistance. They announced a total of $30 billion in uninsured deposits into the bank, reflecting their "confidence in First Republic and in banks of all size". ^[4]

European Spillover

The turmoil made its way into Europe this week, with the stock of Credit Suisse selling off on Wednesday, after the Saudi National Bank refused to raise its stake, according to Reuters ^[5]. A day earlier Credit Suisse had found "material weakness" in controls over financial reporting ^[6], in the latest in a series of problems that started following its Archegos-related losses of 2021.

The Swiss National Bank eventually came in support, saying that it will provide liquidity if necessary, stressing that CS meets the necessary capital and liquidity requirements ^[7]. Credit Suisse tapped that credit line to "pre-emptively strengthen liquidity by intending to exercise its option" to borrow up to CHF 50 billion ^[8]

ECB Vote of Confidence

Back in early February, the European Central Bank had stated its intention to increase interest rates by another 50 basis points this month, in order to bring down inflation. This was not a foregone conclusion though, as the banking turmoil could push it into adopting a more conservative approach.

What the ECB described as "market tension" did not eventually sidetrack policy makers, as officials stayed the course on Thursday with an 0.5% increase, to what is seen as a vote of confidence to the financial system ^[9].

The central bank touted its readiness "to respond as necessary to preserve price stability and financial stability in the euro area", while stressing that the banking sector is "resilient, with strong capital and liquidity positions"

No Forward Guidance

The ECB stayed the course and Ms Lagarde spoke of a "very large majority" in favor of the decision, which was taken in "rather record time", showing the banks' resolve. There is less certainly around the next moves though, since officials refrained from providing forward guidance due to the"elevated level of uncertainty" that reinforces the data-dependent approach.

It is understandably difficult for policymakers to pre-commit to a policy path at this stage, since we are still in the eye of the storm, but Ms Lagarde noted that they have "a lot more ground to cover", if their baseline projections hold. She stressed that officials are "not waning" from their commitment to fight inflation and their determination "should not be doubted". ^[10]

EUR/USD Reaction

The pair experienced some two-way action after the decision, but closed Wednesday with profits and rises today, despite the lack of forward guidance. The ECB still hinted to more tightening, the 50 bps rate hike was a vote of confidence, while the robust action by authorities on bot sides of the Atlantic help sentiment.

Major European banks, such as Deutsche Bank, BNP Paribas opened higher today, however caution is still needed as event continue to unfold.