European and US stocks fall sharply on banking sector chaos

US and European stocks were hit hard by chaos in the banking sector on Wednesday as fears over the value of industry bond portfolios after the collapse of Silicon Valley Bank, and the direction of central banks’ next interest rate moves resurfaced.

The US blue-chip S&P 500 fell 1.9 per cent, while the technology-heavy Nasdaq Composite fell 0.9 per cent.

Europe’s stocks slumped, with the benchmark Stoxx 600 closing down 3 per cent, the UK’s bank-heavy FTSE 100 falling 3.8 per cent and France’s CAC 40 off 3.8 per cent as investor jitters extended for a third day.

Bond yields tumbled, with yields on 10-year German Bunds falling 0.31 percentage points at 2.14 per cent, their biggest single-day drop since 1990. The yield on the German two-year note lost half a percentage point to 2.4 per cent.

The yield on the two-year US Treasury note, which closely tracks interest rate expectations and moves inversely to price, fell 0.4 percentage points to 3.82 per cent. The yield on the 10-year note, which underpins global borrowing costs, fell 0.2 percentage points to 3.41 per cent.

The concerns fanned out into corporate bonds, with the gap between yields on junk-rated debt and US Treasuries exceeding 5 percentage points this week for the first time since October.

The US Federal Reserve is balancing the demise of three US banks, which has increased speculation that it will have to pause its interest rate increases earlier than expected, and a series of data releases that point to stubbornly high inflation and a hot economy.

Investors have ramped up bets that the Fed will cut interest rates later this year. Markets are now pricing in, at most, a single 0.25 percentage point increase, followed by rate cuts of as much as 1.25 percentage points by the end of the year.

The KBW Nasdaq Bank index was down 4.1 per cent, while First Republic Bank, a regional bank at the centre of the sell-off on Monday, lost 23.1 per cent.

Fitch downgraded the bank’s rating to BB from A- and placed it on negative watch, saying that its funding and liquidity profile represents a “weakest link”.

“Investors are a fickle bunch and the unknowns are taking a toll on sentiment . . . but this is not a Lehman Brothers moment, it is isolated to regional banks that are a small share of investment grade corporate bonds and small share of employment,” said Ryan Sweet, chief US economist at Oxford Economics. “The Federal Reserve can step in and use the discount window and be a lender of last resort.”

Wednesday’s retail sales data showed that consumer spending declined by 0.4 per cent in February, more than economists’ forecast of 0.2 per cent but “not enough to signal a major deterioration in consumers’ willingness to spend”, said analysts at Oxford Economics in a note. On Tuesday, the consumer price index rose 6 per cent year on year.

Line chart of 10-year Bund showing German bond yields tumble as investors price in US rate cuts

The Euro Stoxx Bank index dropped 8.4 per cent after Credit Suisse’s largest shareholder said it would not provide the Swiss lender with any more capital.

Credit Suisse shares lost a quarter of their value, dragging peers lower. Société Générale lost 12.1 per cent, Deutsche Bank shed 9.3 per cent and BNP Paribas fell 10.1 per cent.

The sell-off in bank shares piled renewed pressure on to a sector already reeling from the fallout of the SVB collapse, and dragged down broader equity markets in Europe.

“Credit Suisse is an isolated case. But banks in Europe, because of regulatory pressure, had to load up on negative-yielding long-duration bonds at the worst time and now they are facing major unrealised losses on the balance sheet and the market is questioning whether Europe could see the same issue as the US,” said Charles-Henry Monchau, chief investment officer at Syz Bank.

Investors also grew cautious that the uncertainty in the European and US banking sectors would force central banks to change potential plans to raise interest rates aggressively to combat inflation.

The European Central Bank meets on Thursday to decide its next interest rate move. Investors are divided over whether there will be a 25 or 50 basis point rise.

“I think central banks not tightening further would be seen as a sign of panic. Given that inflation is still very high, they need to stay the course,” said Emmanuel Cau, head of European equity strategy at Barclays.

Earlier in the day, equities in Asia had rebounded as traders bought financial stocks following heavy selling at the start of the week.

Japan’s Topix added 0.7 per cent and South Korea’s Kospi added 1.2 per cent. The Topix Banks index in Japan gained 3.3 per cent after suffering its steepest decline in three years on Tuesday.

In currency markets, the dollar index, which measures the greenback against six peer currencies, rose 1.29 per cent. Sterling slipped 1.2 per cent against the dollar, in the wake of UK chancellor Jeremy Hunt’s spring Budget.

Oil prices gave up early gains, with Brent crude falling 6.3 per cent and West Texas Intermediate, the US benchmark, trading 6.7 per cent lower.

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