To The Moon

Views are my own. Not investment advice. Just my thoughts on Macro developments.

Overnight we have jumped sharply from risk off driven by a hawkish Fed and higher US yields to panic about the solvency of US banks sparked by Silicon Valley Bank. See here https://www.ft.com/content/47e3d4a7-70b6-4a4e-98b0-6322f8e8ba53

To quickly summarise Silicon Valley Bank has been facing problems meeting demand for customer withdrawals. Being a relatively new bank and focused heavily on the Silicon Valley Tech sector it’s entire client base have been having synchronised issues with the sharp collapse in tech stocks last year. As a result withdrawals have been increasing as these tech companies need the cash and the sudden outflow of deposits is causing a liquidity issue for the bank. To meet this kind of demand for withdrawals regulators ensure that banks hold significant capital buffers. The problem that now seems to be showing itself here is that banks have generally bought Treasuries to hold as a cash like instrument to meet these capital requirements. To prevent banks from having huge PnL swings on these Treasury holdings they are allowed to hold them in accounts called “hold to maturity” for accounting purposes. This means that the mark to market losses are not realised. This all works fine until a bank has liquidity problems and then needs to access this capital. They are then forced to sell the liquid Treasuries in their “hold to maturity” account and therefore realise those mark to market losses that are there due to higher rates. So the big question then becomes… Is this a problem for banks as a whole in the broader financial system? Right now the market is taking a “sell first and ask questions later” approach. This is what has driven the large selling of US bank stocks overnight and a flight to safety in US treasuries. I am no expert on the accounting practices and solvency of banks so if anyone has anything insightful to say on this please let me know.

It is important to note that there are two different kinds of risk aversion here. The last couple of weeks has been risk aversion driven by fear of a hawkish Fed and higher US rates. This type of risk aversion leads to USD demand but also weighs on low yielders like JPY, Gold and CHF as the market looks for yield in USD. That risk aversion has now morphed into what I would call “traditional” risk aversion where the market is concerned about systemic risks and therefore looks for safety in traditional havens such as US Treasuries. This kind of risk aversion is defined by lower US rates. USD will still get safe haven demand in this environment but the market will also flood back into low yielding havens like CHF, JPY and Gold. This creates a tough trading backdrop. Right now it difficult to determine which kind of risk aversion we are in as we are in a mix of both. If the Silicon Valley Bank problems fade into the background along with the graveyard of Crypto firms last year then the market will go back to focusing on higher US rates and buying USD. Although if this turns into a larger systemic issue then the traditional safe havens Gold and CHF will outperform. I think it makes sense to be defensive and be short a basket of growth currencies whilst long USD, CHF and Gold. It has been clear for some time that higher US rates would eventually start to break some of the fragile parts of the economy that developed under near zero interest rates. Those cracks could now be showing.

Kuroda stuck to his rhetoric that the BOJ needs to remain in easing mode to support wage growth that is still not proving persistent enough. The risk of a hawkish shift from the BOJ has been kicked to later this year or even next year. The risk of amendments to YCC remains though as the JGB market is as dysfunctional as ever. With Japan yields still firmly capped USDJPY is free to be a function of US yields. The sudden move lower in US yields overnight makes this a difficult one to trade but I keep a bias for USDJPY higher given the stark rate divergence bit will need to take. the lead from US yields.

I noted earlier this week that the market is long growth currencies, particularly in EM where the market has been hunting for yield. Those positions are looking particularly vulnerable now. The reversal higher in USDMXN is particularly notable and I expect this move has legs. Of course a lot will still depend on US NFP today. A strong number amongst a backdrop of fragile risk sentiment could weigh heavy on growth currencies into the weekend. A weak one will give an added boost to those low yielding havens CHF, JPY and Gold.