Jason Daw:
Hello and welcome to Macro Minutes. During each episode, we'll be joined by R B C Capital Markets experts to provide high conviction insights on the latest developments in financial markets and the global economy. Please listen to the end of this recording for important disclosures.
Peter Schaffrik:
Welcome back everyone to Micro Minutes. My name is Peter Schaffrik, and I will be your host today. The time of recording is uh, 2:00 PM London time, 9:00 AM Eastern, and today is the 4th of April, 2023. The last two times when we met here, we were talking a lot about financial turmoil. Actually, P Credit square is, and the odds of whether the tentative wobbles that we saw in markets and in these institutions would morph into a systemic crisis. Financial market volatility exploded. Bank stocks were falling sharply. Credit spreads widened and rates market reversed. A lot of the implied rate market, uh, rate high, um, implications that we had built in prior the primary market for corporates and specifically financials froze. Now, looking back over the last week and a half, the picture looks much calmer, or at least the market collectively is, uh, breathing as sigh of relief and is desperately seeking calm, which is also the title of today's edition.
So I think the debate has moved on quite a bit actually already, um, from financial how to, to how much financial tightening will remain as the result of the volatility that we've seen, and whether this can be offset, at least to some degree by less rate hikes than we previously assumed just overnight. The RBA has just followed the Bank of Canada and paused its rate, hiking cycle, short end rate expectations for most of the other markets where central banks are still in hiking mode, have now stabilized but at lower levels than about a month ago. So for Sonya, as the forwards, they're all uprising about 50 basis points, less rate hikes than at the end of February. And in my mind, the debate will next move to whether the combination of tighter financial conditions as a fallout from the volatility that we had and lower rate hikes than we previously assumed would be sufficient to seriously dent the economy and crucially the labor market.
And because of the lags, given that this question is unlikely going to be answered in the near term, the recent newfound tentative stability in the market led to a sharp drop in realized and implied volatility already. And I expect this trend to continue. Barring any further blowups, longer dated treasury Bond Guild yields have all stabilized now and credit spreads have started to tighten again. Equity markets, including the packet bank stocks in Europe have recovered again, and I think this is sort of what we're trying to investigate today a bit more in detail. And to help us navigate this difficult landscape, I'm joined by a strong roster of RBC experts. So we'll start off with Blake Gwinn, who will talk us through the latest developments in the US and he has recently written a very insightful note about deposit flows in the US banking system and the draw on the Fed liquidity provisions. He'll start us off. He's gonna be followed by Sean. He's our head of European DCM and syndicate who will walk us through the development in the primary market, which I have pointed out repeatedly are key part of the financial conditions debate, Jason Daw, which has views on the US and Canadian bond market. We'll finish off with Adam Cole, who can hopefully shed some light into what is all means for the US dollar and another FX pass. So without further ado, uh, turn it over to Blake.
Blake Gwinn:
Yeah, thanks Peter. Um, so look, I think it's been, um, helpful, uh, in talking with clients to kind of, um, break down this re recent banking stress into kind of three different, um, components here. Uh, this just helps kind of clarify, um, you know, the arguments clarify the discussion. So, um, the first, the, the, the first impact I think we have, um, that the Fed is concerned about is really contagion risk. Um, that was how interconnected are these banks of the financial system, you know, is is are these banking stresses going to, um, trigger some kind of broader fear that's gonna turn into, uh, broader banking issues and, um, you know, really kind of turn, uh, into broader systemic risk similar to what we've seen, um, you know, great financial crisis, something like that. Um, I think the second aspect here is really, uh, the degree to which this banking stress has really been a harbinger of, of other troubles to come.
Um, so not so much that, um, you know, these banks were interconnected into other areas of the fin um, the financial system, but more, um, you know, more whether these are kind of a sign of difficulties that are going to come because of the, the fed hiking rates. Um, and then lastly, I think is the issue of the credit condition tightening. Uh, to what degree are we gonna see a broad pullback by banks, um, you know, credit creation and to what extent is that going to drag on the economy? Uh, from the Fed perspective, I think they're very confident on the first of these. I think, um, you know, we're especially three weeks on and we really haven't seen any signs that stress is broadening out, uh, to other banks. Um, you know, aside from the liquidity provisions that have been tied to bank payers, uh, most of the borrowing that we saw from the Fed and the F H L B system here in early March, uh, Luke to have largely been precautionary, we don't really see that demand, um, you know, broadening out, uh, you know, getting larger, more increased, uh, you know, more demand for loans or advances from, uh, the Fed or F H L B.
And already we're seeing, um, you know, seeing that stress start to fade to varying degrees across these various products. Um, on on the second piece, what, you know, whether or not, um, this banking stress is really a harbinger of, of other troubles to come, I think you can construct, uh, a decently convincing narrative that these were very idiosyncratic issues, you know, relatively isolated issues of mismanagement, uh, rather than some kind of early sign of broader fragility, uh, that's going to come because of raid hikes, but I don't think the Fed can be entirely sure of that. Um, so these doubts are likely to linger and I think all else equal, uh, do help to keep the terminal rate in check. Um, lastly on the pullback and bank credit provision, um, that is almost certainly going to happen, but the magnitude of that pullback and what that pullback is actually going to mean on, uh, the broader economy are still very, very uncertain.
Um, you know, this uncertainty more so than the other two, uh, items I mentioned is really why I think the Fed pulled back from a 50 basis point hike in March and left their 2020 three.at five and eights. Um, there's been a lot of effort across the street to kind of express this pullback in terms of rate hikes, to be honest, we don't have a major view on this. And if anything, um, you know, I think kind of relating hikes, which work through the demand side to a tightening and lending, which is really going on the supply side, seems a bit fraught. Um, but you know, if we look at what the Fed did, if we assume that they were going to increase their 2023, uh, rate projections but didn't, uh, we can imply that their initial thoughts are that this is worth something in the order of one to two hikes.
And if we look at how market pricing shifted, um, you know, that's suggesting that this has been worth two to three hikes, uh, as well. Um, for our part, we still said hiking in May, uh, and then pausing at five and eight consistent with what the Fed said in their most recent s e P. Um, however, uh, we do wonder if the market's too quickly down the possibility for return, uh, to the narrative that existed in early March after PS congressional testimony, uh, before all this banking stress started. Uh, we could certainly envision a scenario where, you know, no other shoes drop on the banking side, uh, confidence that these recent failures were idiosyncratic, uh, starts to broaden. Um, banks start to tighten financial conditions, but it really doesn't drag on the economy to the extent many you're expecting. Uh, we get data that can use to meter exceed expectations.
Um, you know, I I would say also oil continuing to rise. Um, you know, if all those conditions, um, you know, take place in the, in the next two to three months, we could certainly see a scenario in which the Fed hikes in May keeps the door open and, and that the terminal rate comes back into play, which we think markets would really view as increasing the risk for a hawkish policy error. So, so that's not our modal view, but I think it's something that's cert a risk that is meaningful enough, uh, for people to keep in mind and, and something that should be hedged against. Um, so I will leave it there and, and pass it along.
Peter Schaffrik:
Thank you, Blake. That's very insightful as always. And with that, I'll hand it over to Sean to speak about the developments in the primary market.
Sean Taor:
Uh, thank you, Peter. Um, I guess if you look at the primary market, particularly in Europe, uh, and look back on the first quarter, well, in fact, before that, look at where we ended ended last year, it wasn't necessarily gonna be an easy quarter. Interest rates were still going up. We were nowhere near, uh, terminal rates. Uh, yields were rising, inflation was sticky. And I think the outlook for most issuers, looking back at, uh, November, December last year was that it was gonna be a very tricky first quarter. Uh, but actually things pan panned out pretty well. Uh, I think partly because cash had built up there hadn't been a great low supply in the fourth quarter, quarter of 22. Uh, and as yields rose investors actually thought it was a good time to put money to work. So if the first two months of of this year things were pretty consistent and pretty steady and, and conditions in primary, whilst maybe new issue premiums, slightly wider conditions were generally very good.
The markets were open most weeks, most days, which is very encouraging. You need a good first quarter in dcm. And then we hit March and again, beginning of March, uh, treasuries were just above 4%. Buns were heading towards 3%. They're roughly 2.7%. Uh, and then the first full week of March, that's when Silicon Valley Bank was, uh, was, uh, you know, effectively taken over by the F D I C. The week afterwards, the ECB put rates up as expected, but then that weekend, credit Swiss, uh, ended up being merged with ubs. And the week after that, you had the Fed putting rates up the Bank of England, putting rates up, et cetera. Uh, and, and things came very quickly to a halt. But what really struck me is how quickly Europe recovered, not just in isolation, but compared to other markets. Normally Europe follows the us, lead US is a very deep market, very deep investor base, very large issuer base.
Actually, the US was pretty quite mid-March, whereas Europe actually plowed ahead pretty much business as usual. It wasn't, it wasn't plain selling every day, but for example, the week the Fed put rates up the day the Bank of England put rates up, uh, VW came out in the Euro market. It was a transaction we were involved in and ended up printing one and three quarter billion across three and six years. Uh, and demand was huge, the order, but was just shy of six and a half billion. And that was in a market where perhaps in previous years, access to funding and it really is key access to funding was questioned, but it was definitely available. And really since then, we've seen a continual and fairly speedy improvement in conditions across all asset classes. Last week, for example, in the us, 25 billion printed in Europe, 17 billion worth of investment grade of that 7 billion was corporates, 10 billion financial institutions, plus another 13 billion in ssa.
So a 30 billion week in Europe last week, which again, for the end of the first quarter is a really strong week, admittedly in the, in financial institutions of that 10 billion, the vast majority was the cover bonds. And I guess if you look at the issues around credit SU and the banking sectors in general, it really shouldn't surprise anyone that the bulk of issuance has been covered. The, the question really is when will the senior market reopen? When will the subordinated market reopen and dare, I said, what about a tier one? Well, this week is a good example, just, just a few days later, there's a European bank BNP in the market with a senior non-preferred transaction, uh, and they have demand over 2 billion. They've tightened the pricing 20 basis points, uh, and it's gone incredibly well. Ax are in the market today also with a tier two transaction, again, gone incredibly well, the book over 4 billion.
So it seems to me as if investors have really put the troubles that we saw in March to one side, and they've seen rates which dip down, don't forget burns, which were, as I said, around 2, 2 70 or so, dip down well below 2%, about one 90. They're back up now at two 30. I think investors see this as a, as, as a really good entry point. And they haven't seen the wall of supply really over the last two or three years. And perhaps that's partly more down to economic conditions than demand. Demand is still incredibly strong. New issue premium is back now in just two or three weeks to pretty much normalize levels. But at the last step, I'll leave you on quarter to one, where does Europe figure compare to previous years? When you look at total issuance cover bond space, pretty much the same as last year, about 80 billion slightly up on last year, but roughly, uh, aligned senior space, actually 90 billion in Europe has already printed this year.
That's up 50% year on year. That's an incredible number considering how tough it was across March corporate space, up maybe small, pretty much flat, not necessarily always a busy month in January, but normally a good month, but year on year, pretty much consistent. Uh, and SSA is incredibly strong, partly because the spreads are core government yields is, is is so high given how, given where swap spreads are, but overall in Europe, Q1 2023, 517 billion worth of investment grade issuance. Not only that, is that a high number? That's the highest number the market has ever seen. It's a record quarterly issuance and up 10% year on year, and that compares to the US market, which is down about 15%. So all in all, I think, going back to your original question, Peter, has the mark have the markets recovered? Well, not a hundred percent, but there are, they're arguably far stronger, far quicker than really almost anyone predicted.
And do banks, corporates, ssas have access to funding? Absolutely, 100% they do. So I guess my, my summary is very, very strong market in Europe. Very strong demand investors when they choose to come, have seen still very high order books and can drive the price down 10, 20, 30 basis, 30 basis points from initial guidance to final landing spots. So in short, it's been a very strong q1. If I look forward, there's no reason I've gotta caveat that and sort of touch wood. There's no reason why, certainly in the short term, that won't continue because investors are seeing terminal rates quicker and they're seeing where we are in terms of spread and yield and improving credit conditions as a real positive. I'll leave it there, Peter.
Peter Schaffrik:
Thank you, Sean. That all sounds quite encouraging. Um, and with that, I, we'll move over to, uh, north, north America again, and then hand over to Jason Daw.
Jason Daw:
Okay, thank you, uh, very much. As Peter mentioned the start the call, uh, markets are indeed, uh, calmer over the past, uh, couple of weeks, but, you know, a calm market's not necessarily a feel-good market. So what's particularly interesting to me is that, you know, in the US the, you know, regional bank index, you know, remains close to its lows. And US dollar IG Senior and subordinated bank credit, you know, it has tightened from the wides, but it's still a decent amount away from the levels, uh, from a month ago. And when looking at government bond space, you know, after popping higher, uh, bond yields in US and Canada, they're close to revisiting the lows that were reached on March the 24th. So I think what's happening here, at least in government bond space is that, you know, after the flight to quality flows, uh, the reversal of, uh, volatile market conditions, you know, is the realization that the economic damage from tighter credit conditions, uh, that was in place and the second half of last year already, and now compounded by, um, probably more tightening in credit conditions by small banks, does present a real risk, uh, to the growth downturn being larger, uh, than otherwise.
So, um, you know, when you look at, you know, how important small banks are, you know, they have loaned more than the larger banks in the US over the past two years, and especially in areas like commercial real estate and also in, uh, the residential, uh, sector. So, you know, the upshot I think is that, you know, bond yields, you know, should be biased, uh, lower through this year. Um, you know, you can have a situation where they move higher, but it's probably not sustained. So I do think this year is all about being, uh, long duration and you just need to pick your battles on, uh, size and timing. Um, another factor that, you know, could fuel the push in bono's lower, um, you know, is shortcoming. Uh, or I think maybe even more importantly, the lack of dry powder to add to shorts.
So when you look at the, um, CFTC data and the information on speculative accounts, um, there's still quite net short US fixed income and, you know, this is corroborated by what we're seeing in leveraged, uh, fund returns. So, you know, yields, uh, leaking lower, you know, could, you know, be helped by, uh, the positioning, uh, angle. Um, the topic I wanted to talk about is the outlook, uh, for Canada. So, um, we do maintain our view that the Bank of Canada will be on hold in 2023. The business outlook and consumer outlook surveys, uh, that were released yesterday, uh, did provide a sigh of relief. Um, because when you look at what's been happening in q1, the labor market has been quite strong and Q1 growth is tracking, um, you know, to the strong side also. But the outlook surveys, which the bank, uh, puts, uh, quite a bit of weight on and the forward-looking information there, you know, is telling us that things are moving in the, uh, right direction regarding inflation expectations and, uh, production constraints.
So that does support our view that the bank, uh, will be on hold, uh, probably this year. Um, when you look at market pricing, you know, the chance of a small cut by July and almost a full cut by September, you know, we think seems outta place versus the macro data and would really require an escalation of the financial stability risks. So fading near term cut pricing does still continue to make sense, but we wouldn't fight the two rate cuts approximately that are priced into the end of, uh, 2023. Um, you know, by the fourth quarter, yes, the chances of a rate hike would prob or rate cut would probably, uh, start to, uh, increase, uh, quite significantly. And while our base case is, um, the cutting cycle should start in Q1 next year, obviously that's boiling hairs, uh, Q1 versus uh, q4, but still between now and q3, uh, the chance of, uh, uh, rate cut is very unlikely we think. And with that, I'll turn it back to Peter.
Peter Schaffrik:
Thank you Jason. Um, as always, very insightful. And, uh, our last speaker on the effects market is gonna be Adam, um, Adam Cole. Here you go.
Adam Cole:
Thanks Peter. So, um, uh, in his introduction, Pete said, we look at the outlook for the dollar and for other currency pairs, and I hope going forward it will be more of a latter and less of a former. Um, so just looking back, um, after 2022, which was just wholly dominated by dollar up or dollar down up for the most part, um, for the first quarter of this year, quarters just ended. Um, in fact, uh, the dollar has barely been a theme, um, in that terms through q1. Uh, the dollar index was down just 1% and the height low range through the course of q1, uh, which is 5%, um, half the range of the previous two quarters. Um, so it, it from fx, um, it, it does feel like we have left behind this, um, very dollar driven market that we live with for the whole Earth 2022.
And I think as we've talked about before, so long as we can leave behind this environment of co movement of equity and bond markets, then that can probably stay the case. Um, it was the parallel selloffs in bonds and equities last year that really pushed us into this, um, dollar directional quadrant of, uh, of returns in fx. And if we can reestablish a little bit of negative correlation between bonds and equities, so that dollar direction should fade. So where, where do we look for that going forwards and what are the themes that will play out if we do have, um, as Peter highlights, a slightly calmer asset market background. And we don't have these parallel selloffs in bonds and equities that we lived with for last year, and I think there are two themes and two, uh, at least two trades that come out of them unless they, we come back to in FX in an environment where interest rates and interest rates spreads have widened but start to stabilize.
The first is, um, yen under performance. Uh, one of the big themes of last year, which I think is still valid, and that is all about, um, the level of rates rather than the dynamic in rates and how the investment world has changed for a yen based investor suddenly faced with, um, hedging the costs after almost 20 years of almost cost free hedging suddenly, um, in losing FX risk costs. And that bottom line from that for us is that it's, again, negative in loose domestic investors, sellers of their own currency. And then the second theme I pick up is if rates and markets generally can stabilize something we really have to focus on a little bit more is the dispersion of interest rates in levels terms, even just within developed markets. We've not seen this degree of dispersion across markets, um, in front end rates, uh, not just back to pre pandemic, but back to pre-financial crisis, um, is how far back we need to go to find an interest rate.
Uh, a level of interest rate dispersion as wide as it is now. And that's combined with a relatively calm asset market environment, uh, does suggest to us that we should be thinking a little bit more about carry in, um, the G 10 world, not, not to the extent that carry dominates our world as it did back pre-crisis, but um, that it's creeping onto the agenda as a viable SX strategy. So couple of threads we like on the back of that over the medium term. One is to be long New Zealand and short Sweden, two currencies that have very different yields, but very similar, uh, risk characteristics. And then if we broaden it out to G 10, em crosses to be Long Mexico and short Canada. Again, widespread and volatility suppressed as the fundamental drivers for both of those currencies are in many cases similar. So those of us who themes I think in this calmer environment, um, that we come back to, um, is focusing a little bit more on the level rather than the rate of change rates. And that makes us negative on the yen and the poorest positive. Um, thematically on, uh, on Carrie and with that, uh, back to Peter.
Peter Schaffrik:
Well, thank you Adam. So I think what we've learned, or at least what I've learned is, um, as long as the market is calmer, um, we don't get any and we don't get any spillovers into other asset markets again, and that's certainly the indication at present. Um, as Blake has highlighted, the primary market remains open and remains quite active, and that's a positive sign. Nevertheless, whether or not this has any long-term ramifications for the economy remains an open question. And therefore, as Jason has highlighted, um, it's, uh, it's always difficult to fade the implied rate cuts, uh, further out the curve. And certainly what Adam has highlighted, um, is that whether or not we get co movement between bond and equity markets is crucially important for where the dollar is going. But also as long as the level and the dispersion of rates is relatively wide, this opens up the possibility for, uh, for carry trades in the FX market. With that, I thank everyone for listening in and I hope you're going to join us again in two weeks time. Four micro minutes.
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