Early lift in risk appetite gives way to renewed concern over wipe-out of AT1 note holders, but risk appetite does recover. US bank stocks mostly higher but First Republic Bank in more trouble

Market conditions have been volatile following the deal brokered over the weekend for UBS to buy Credit Suisse. The US 2-year rate has traded a 40bps range.  Both the 2 and 10-year rates are currently higher on the day. Equity markets are higher, recovering from earlier losses. The NZD’s move early yesterday above 0.63 proved short-lived and it has settled around 0.6250, underperforming for the day and down on all the key crosses.

Risk appetite opened the week on a positive note, following the government-brokered deal for UBS to buy Credit Suisse for CHF3b, supported by $100bn of liquidity by the Swiss National Bank.  The NZD was up through 0.63 in early trading, global rates were higher and US equity futures were positive. Those moves were unwound through Asian and early European trading, with the US 2-year Treasury yield down to 3.63% at its low, the 10-year rate down to 3.29%, and S&P futures falling 2%, before a subsequent bounce-back in yields and equities.

The complete wipeout of holders of Credit Suisse’s additional tier 1 (AT1) notes (with a face value of $17b) got the market’s attention, coming as a surprise to most, given that investors in the notes came out worse off than the equity holders, who at least receive some UBS stock – the decision seen as privileging equity holders over holders of the firm’s riskiest bonds.

Digging into the detail, Credit Suisse’s AT1 notes carried a clause that if the bank is getting “extraordinary support” from the government or central bank, then the notes could be completely written down. AT1 debt issued elsewhere don’t necessarily have that clause and instead state that ordinary shares are written down first. Given the importance to the market in clarifying this issue, EU authorities and the Bank of England issued statements.  The BoE said the “UK’s bank resolution framework has a clear statutory order in which shareholders and creditors would bear losses in a resolution or insolvency scenario”, noting that holders of instruments would expect to be exposed to losses in order of their positions in the hierarchy. The EU authorities’ statement contained a similar message.

Still, the move has been shocking enough to reduce the value of other AT1 issues in the market (down in the order of 5-15% for newly issued European AT1 bonds) and possibly destroying the market for future issuance of these sorts of bonds that banking regulators supported.

There was also some anxiety over the announcement on the enhancement of the Fed’s USD swap lines, with all parties (BoC, BoE, BoJ, ECB and SNB) agreeing to increase the frequency of their operations to daily from weekly – a seemingly unnecessary step at this juncture and raising the question, what do the central banks know that the market doesn’t?

Now that the dust has settled, risk appetite has returned to the market. The FT reported a US official saying “bank deposits in the US had stabilised, with outflows from the most vulnerable institutions slowing, stopping and in some cases reversing”.  The WSJ’s lead article notes JP Morgan CEO Dimon is leading discussions to with the CEOs of other big banks about fresh efforts to stabilise First Republic Bank – its share price has been haemorrhaging despite last week’s transfer of $30b in deposits to the bank.

So, after another wild trading session, the S&P500 is currently up 0.8%.  The KBW bank index is up nearly 2%, with most bank shares higher.  First Republic Bank looks to be the only troubled bank in the current spotlight, falling close to 30% (again). The smaller regional bank index shows 44 of 48 banks trading in positive territory and the four losers show insignificant losses. The Euro Stoxx 600 index rose 1%, with all sectors higher. UBS shares were down as much as 16% in early trading and finished the day up 1.3%.

US Treasury yields are currently trading near the top end of their wide daily range, the 2-year rate back towards 4% and the 10-year rate near 3.5%.  The better signs in the US banking sector have helped nudge pricing for this week’s Fed meeting to +17bps.  Still, there is some conviction that the end of the tightening cycle is near, and the Fed will be easing policy from as soon as June.

Currency markets have displayed much less volatility than rates and equity markets. In overnight trading the NZD has been in a tight range of less than 30pips, settling around 0.6250.  There has been an unwinding of some of last week’s outperformance of the NZD, and it is the worst performer overnight and since last week’s close, seeing it weaker on all the key crosses. The AUD has pushed up to 0.6720, seeing NZD/AUD back down to around 0.93. A higher EUR and GBP sees NZD/EUR down to 0.5830 and NZD/GBP just below 0.51. JPY has been whippy alongside US Treasury yields, with USD/JPY trading a range of 2 big figures and currently down slightly to 131.60.

The domestic rates market was quiet but rates were marked lower on the back of the significant global moves. NZGB and swap yields fell 17-19bps. The Australian 10-year bond future has traded a wide 20bps range overnight but currently sits only 2bps lower in yield terms since the NZ close.

In the economic calendar ahead, it is mostly second-tier data apart from Canada’s CPI release, expected to show weaker headline and core annual inflation. Focus will remain on the banking sector and funding markets.