Traders Run for Cover as US Banking Woes Spur Haven Demand

(Bloomberg) — Government bonds surged and stocks slid as signs of distress at a California lender spurred broader worries over the US banking sector’s debt holdings.

Most Read from Bloomberg

US and European bond yields tumbled to their lowest in weeks as traders bet any turmoil at banks could reduce the ability of the Federal Reserve to keep hiking interest rates. The Stoxx Europe 600 Index slumped the most since December, led by banking shares, with the cost of protecting against corporate defaults jumping the most this year.

Markets are jittery on the potential fallout from Silicon Valley Bank — a small technology-focused lender — which has suffered significant losses on a portfolio including US Treasuries and mortgage-backed securities. That sparked a global selloff in stocks, with investors now turning their attention to risks that may lurk in other financial institutions after the Fed’s steep rate hikes.

“Broader banking concerns may put question marks behind the pace the Fed is able to raise interest rates,” said Christoph Rieger, head of fixed-rate strategy at Commerzbank AG.

Traders pared wagers on the scope for further Fed policy tightening, which has eroded the value of holding Treasuries. The odds of a half-point increase this month have fallen to 50% compared to 75% previously. Money markets are now pricing a total of 91 basis points of hikes by July, compared to 112 basis points on Wednesday.

That drove down 10-year Treasury yields by as much as 11 basis points to a three-week low of 3.80%. German 10-year government borrowing costs also slid as much as 17 basis points as markets eased wagers for a peak in European Central Bank’s terminal rate to below 4% for the first time this month.

One Bank Folds, Another Wobbles and Wall Street Ponders a Crisis

While US equity futures only pointed to a muted drop on Friday, Silicon Valley Bank’s shares slumped 36% in US premarket trading, following Thursday’s 60% losses. Adding to the souring sentiment was Silvergate Capital Corp., which plans to wind down operations and liquidate after the crypto meltdown sapped the company’s financial strength.

“The setup from the US makes for a gloomy trading start this Friday. Investors have been shown in a very clear way what the rate hikes can do to the economy,” said Frank Sohlleder, a market analyst for ActivTrades.

In Europe, the Stoxx 600 Banks Index slumped as much as 4.9%, the biggest drop since June. Germany’s Deutsche Bank AG and Commerzbank AG posted the steepest losses, the former falling more than 9%, while Credit Suisse Group AG hit another record low.

However, Oliver Scharping, a portfolio manager at Bantleon, says there are only limited cross-overs for European banks. If the sector continues to remain under pressure in sympathy over the next few sessions, contagion could be an opportunity to add exposure, he said.

“While I’m getting arguably some Bear Stearns ‘08 vibes and liquidity is disappearing across the board, it doesn’t feel like a systemic issue yet,” he said.

The risks within the US banking sector have emerged just ahead of Friday’s monthly jobs report, a key figure in the outlook for further rate increases. Economists project a 225,000 increase in February payrolls, about half January’s blockbuster pace, and a softer number could further tilt expectations back to a quarter-point Fed hike.

“The ongoing concerns over SVB would set a fragile stage for the important NFP release today,” said Mohit Kumar, rates strategist at Jefferies International. “A higher than expected number would exaggerate the market reaction in equities; while a weaker number would exaggerate the market reaction in rates.”

Far-Reaching Impact

A measure of European banking stress in funding markets rose to the most since April 2020. The impact is also being clearly seen in credit. Insuring a €10 million ($10.6 million) basket of junk bonds for five years now costs about €418,000 annually, from under €400,000 at close of business on Thursday.

Safeguarding baskets of bank bonds is also getting more expensive. The subordinated financial sector is the only part of the euro-denominated high-grade market where risk premiums are widening on Friday, based on data compiled by Bloomberg.

Meanwhile, most contingent convertible bonds, the riskiest type of debt issued by European lenders, are suffering price drops. A Swiss franc-denominated note by Credit Suisse Group AG leads losses with a 0.9 point drop to 72.3 percent of face value.

“By exposing its weakness, SVB has somewhat opened Pandora’s box,” Arnaud Cayla, deputy CEO at Cholet Dupont Asset Management, told clients in a note.

–With assistance from James Hirai, Tasos Vossos, Ksenia Galouchko, Julien Ponthus, Giulia Morpurgo and John Viljoen.

(Updates throughout.)

Most Read from Bloomberg Businessweek

©2023 Bloomberg L.P.