A downhill slide for banks and oil

Energodigest | 23 March 2023
Inflation across major global economies has been running rampant over recent years, fueled by the COVID-19 pandemic and the energy crunch, with central banks forced to tighten their monetary policy and raise interest rates in response. In the US, for example, the Fed is determined to bring inflation back down to the 2.0% target (for comparison, inflation stood at 8.2% last September[1] and 6.0% this February[2]), having raised its benchmark interest rate eight times since last spring by a total of 450 b.p. (see Fig. 1). In February 2023, the federal funds rate was upped by 25 b.p. to a target range of 4.50%-4.75%, its highest level since late 2007.

Climbing interest rates have choked off access to cheap finance needed for expansion and growth across many industries, including the technology sector. After a massive outflow of clients and losses on long-term bonds, California financial regulators closed down the tech lender Silicon Valley Bank (SVB), which ranked as the 16th-largest US bank by total assets, citing inadequate liquidity and insolvency. SVB’s closure was followed by that of its competitor, Signature Bank. The collapses of SVB and Signature Bank were the second- and third-biggest failures in US banking history, respectively.

While it’s yet unclear if this will be a problem for many banks or just a few, the turmoil it triggered on the markets has cast doubt on whether the expectations of a further major rate hike will come true. At its March meeting, the Fed raised its benchmark interest rate by just 25 b.p. instead of the anticipated 50 b.p. However, the malaise in the banking sector is spreading outside North America, with Credit Suisse adding fuel to the fire. To prevent the bankruptcy of its oldest financial institution that has been around for over a century and to keep its national banking system intact, the Swiss government decided on a radical step, with the country’s biggest bank, UBS, agreeing to buy its ailing rival in an emergency rescue deal.

Fear has taken hold among investors, with the Volatility Index soaring to its highest level since last November (see Fig. 2). Many remember Lehman Brothers, whose failure in 2008 ignited a global financial crisis, and can’t rule out the possibility that history will repeat itself.
Against this backdrop, oil prices are correcting downwards, to less than $75 a barrel, the lowest level since late 2021 (see Fig. 3). Gold, by contrast, is gaining value as a ‘safe haven’ asset, trading at its highest level in the last 11 months. So far, it seems that investors are liquidating speculative long positions opened earlier in hope for economic growth in China, with industrial output there rising 2.4% in January-February[3] as the country emerges from lengthy lockdowns. Markets are concerned, however, that an imminent global financial crisis could outweigh the growing demand from the world’s second-largest economy. Even the premier of the State Council of the People’s Republic of China said that the modest growth target of around 5% wouldn’t be easy to achieve.[4]
On the oil front, many analysts are trimming their price forecasts in response to market developments. Goldman Sachs, for example, now expects Brent to reach $94 a barrel for the 12 months ahead and $97 a barrel in the second half of 2024, versus $100 a barrel previously. Let’s see how this will affect Russian oil.
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