What a difference a week makes for stock and bond investors.
(Bloomberg) — What a difference a week makes for stock and bond investors.
The shock collapse of Silicon Valley Bank and the turmoil engulfing Credit Suisse Group AG have demolished the pillars holding up the market’s broad narrative for 2023. Suddenly, talk of a hard landing for the economy is back and investors are unwinding their favored trade of being long banks and other cyclical stocks. Dormant volatility has spiked and expectations of further rate hikes are being ditched.
“The Credit Suisse crisis is a highly anticipated event, but its timing cannot be much worse,” said Hebe Chen, an analyst at IG Markets. “The damage it has inflicted on the market is like rubbing salt into the wound and the market will need extra time to regain confidence.”
Here are five charts that illustrate the upheaval in markets over the past week:
Equity traders had found comfort in a narrative that inflation would fade gradually, peak rates in the US and Europe were in sight and that a recession could be avoided. Stocks, sectors and countries with fortunes linked to the wellbeing of the global economy rallied this year. Now, those trades are being rapidly unwound — with popular banking stocks taking the hardest hit.
READ MORE: Credit Suisse Crisis Crushes a Favorite Investor Trade of 2023
Volatility has shot up, with the Cboe VIX Index posting a sharp rise above 30 for the first time since September 2022. Stock market price swings have been restrained for most of this year, with the gauge subsiding to as low as 17 points. Based on the experience of the past year, no major spike in volatility has ended before reaching about 35 points, signaling that the current ascent in the VIX has further to run.
Since 2023 started, stocks and bonds had diverged, showing a disconnect between how the asset classes were pricing the economic outlook. But the dramatic events of recent days have shown that tightening monetary policy and soaring interest rates take their toll on the economy with a lag, and that the Federal Reserve may have hiked too much, too quickly. In recent sessions, the dislocation has narrowed from both sides, with bond yields receding in concert with stocks, as fears of a recession return to the top of investors’ worries.
A dramatic shift in short-term central bank rate expectations has been the biggest driver in closing the gap between stocks and bonds. As risks increase that higher rates will inflict further pain on the economy, policymakers may waver over staying the course in the fight against inflation. Traders’ expectations for the Fed have switched from more hikes through the year to cuts as early as this summer, while implied bets on policy rates for the end of the year have collapsed from close to 6% to just below 4%.
The tumult surrounding Credit Suisse marks the first time since the global financial crisis that investors have feared a potential default by a major European bank. The lender’s five-year corporate default swaps — a derivative contract insuring against the risk of default on a bond — soared to unprecedented levels for a top bank this week, approaching 1,000 points. That’s near levels Greek banks reached — and then exceeded — when the country’s solvency was in question.
Still, unlike during the sovereign debt crisis, the move failed to have much of an impact on the CDS of other large banks, a sign that most market participants aren’t contemplating a broader contagion.
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