Investors face 3 big questions as a rolling banking crisis shakes markets
As concerns over a looming banking crisis weigh on the minds of investors, one economist says what happens next will depend on three major questions:
Have policymakers done enough to avert a system-wide crisis?
How could the situation escalate?
What does all of this mean for monetary policy?
"The most immediate question is how markets digest news of the UBS deal to buy Credit Suisse," wrote Neil Shearing, group chief economist at Capital Economics.
Late Sunday, UBS (UBS) announced a deal to acquire Credit Suisse (CS) for a little over $3 billion, news that sent shares of Credit Suisse down about 50% on Monday while UBS reversed early losses.
Shearing said elements of UBS' agreement are not entirely clear, with the discounted value of $3.25 billion suggesting, "a substantial part of Credit Suisse's $570 [billion in] assets may be either impaired or perceived as being at risk of becoming impaired."
"This could set in train renewed jitters about the health of banks," Shearing wrote.
On Monday, bank stocks were broadly higher.
Still, Shearing notes crises like what markets face today don't tend to come and go in quick bouts.
"Containing crises is a bit like a game of whack-a-mole — with new fires starting as existing ones are extinguished. A key issue over the next week will be whether problems arise in other institutions or parts of the financial system," Shearing wrote.
Whether the banking crisis escalates, in Shearing's view, hinges on any additional unknowns that emerge from the system as the result of aggressively rising interest rates.
"While it's tempting to dismiss the problems at SVB, Signature Bank and Credit Suisse as idiosyncratic, they have revealed that problems are lurking in the financial system as interest rates rise," Shearing wrote.
"Key areas to monitor include smaller European banks and shadow banks, particularly open-ended funds that might suffer from maturity mismatches."
As Yahoo Finance's Dan Fitzpatrick outlined over the weekend, some $600 billion in "unrealized" credit losses are lurking in the U.S. banking system. But these losses, as Shearing notes, are largely the result of banks failing to manage interest rate risk, rather than extending credit to bad borrowers.
"Credit Suisse aside, the problems so far have been caused by a failure to adequately manage interest rate risk," Shearing wrote. "An altogether more serious crisis would develop if credit risks start to emerge — or, to put it differently, if loan default rates rise as banks' asset quality deteriorates.
Which brings in the top concern from investors this week: What will the Fed do?
As of mid-morning on Monday, markets are pricing in a ~70% chance the Fed raises rates by 25 basis points at the conclusion of its two-day policy meeting on Wednesday, according to data from the CME Group.
Prior to the crisis, investors placed a better-than-50% chance on the Fed raising rates by 50 basis points this month.
"This is a perilously difficult path for central banks to tread," Shearing said, adding last week's developments prove money, credit, and the financial sector are just as important factors as macro data like inflation and jobs when it comes to the Fed's policy play.
"While the exact implications of recent events for monetary policy are still unclear, it is likely to mean that interest rates will be lower than the markets had anticipated a couple of weeks ago," he predicted.
Alexandra Canal is a Senior Entertainment and Media Reporter at Yahoo Finance. Follow her on Twitter @alliecanal8193 and email her at email@example.com
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