You know things are getting serious when the Bank of England is forced to step in and buy bonds because the country’s entire defined benefit pensions system is put in danger because of rocketing bond yields.
Admittedly, the UK problems were fairly directly caused by Prime Minister Liz Truss’ hare-brained decision to meet rising interest rates head on with an unprecedented and unfunded round of tax cuts, but increasingly there are stresses and strains building up within the financial system as inflation leads to intense monetary tightening.
Speculation swirls around Credit Suisse and Deutsche Bank
Some of the most intense speculation has surrounded the future for large financial institutions Credit Suisse and Deutsche Bank, with both attracting market attention as their share prices continue to tank and trading in their credit default swaps reaches levels not seen since the Lehman Brothers collapse.
The speculation saw Credit Suisse chief executive officer Ulrich Koerner last week reassure investors and staff – admitting that the bank is facing a “critical moment” but stressing that the Swiss-based financial institution has a “strong capital base and liquidity position.”
In a memo to staff he wrote: “I know it’s not easy to remain focused amid the many stories you read in the media – in particular, given the many factually inaccurate statements being made.”
“That said, I trust that you are not confusing our day-to-day stock price performance with the strong capital base and liquidity position of the bank,” Mr Koerner said.
Painful restructure to come?
Not everyone has been calmed by this reassurance, with many saying that at the very least Credit Suisse will need to go through a painful restructure to repair its ailing investment banking arm, which was hit hard by the collapse of secretive New York hedge fund Archegos and other bad debts.
However, other traders think the pessimism has been overdone and have rated Deutsche Bank as a buy and remain confident that Credit Suisse and its strong and valuable banking and wealth management platforms will provide enough of a buffer to allow it to rescue and restructure its poorly performing investment bank.
Both banks have attracted negative speculative attention before and come through, but there is little doubt that they are both in a less than ideal state, particularly Credit Suisse with a share price that is down more than 70% – from 14.90 Swiss Francs in Feb 2021, to trading around 3.90 Swiss Francs now.
UK market intervention puts focus on financial risks
The attention on Credit Suisse and Deutsche is understandable given the dramatic intervention by the Bank of England in the UK bond market.
Yields on 30-year UK Government bonds whizzed straight through the 5% level after the unfunded Truss tax-and-spend plan was announced, which was the equivalent of the government stomping hard on the accelerator at the same time as the central bank was pushing firmly on the brakes.
Bond yields on gilts (the name given to UK bonds) are not normally anything like this volatile, having risen from just above 3% and this volatility and uncertainty caused the pound to come close to parity for the US dollar after a plunge of more than 20% this year alone.
Pension funds and home loans under threat
The Bank of England was forced to intervene because lending for housing was starting to be hit and the rising yields had caused a potential crisis in the UK pension fund sector.
Unlike Australia, the UK pensions market is largely made up of defined benefit schemes under which the funds need to match their long-term liabilities with assets.
Rising gilt yields caused a dramatic fall in the capital value of the gilts on the pension fund books – a problem made worse by the use of leveraged derivatives by the funds.
If the funds had been forced to start selling their bonds to support those derivative positions the crisis would have become full blown – although even the dramatic intervention has only calmed the situation for now.
Credit Suisse diagnoses its own problems
As Credit Suisse itself said in some recent research, the world is facing some difficult economic times.
“Higher rates combined with ongoing shocks lead us to cut GDP forecasts,” the bank research said.
“The euro area and the UK are in recession, China is in a growth recession, and the US is flirting with recession.”
Credit Suisse predicts global GDP will be just 2.6% this year and 1.6% next year, which will cause deteriorating conditions on financial assets.
The fact that Credit Suisse itself, along with Deutsche bank, has been caught up in the turmoil on financial markets caused by rapidly slowing economies is hardly surprising but nonetheless somewhat ironic.