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What the banking collapses mean for currencies

By the OFX team | 4 April 2023 | 5 minute read

When a 157-year-old financial stalwart and an upstart funder of startups go belly up in the same month, markets get very nervous.

Echoes of the Global Financial Crisis have been reverberating across the Western world as investors wonder whether the collapse of Credit Suisse and three US banks, Silicon Valley Bank (SVB), Signature and Silvergate is the start of a wider contagion.

Credit Suisse is a globally significant institution, while the three failed US banks represented over US$300 billion of assets. That represents the largest annual value assets affected in the last forty years, outside the height of the GFC.

Unlike the Global Financial Crisis, this time regulators stepped in quickly to stop contagion, with the US Federal Reserve guaranteeing deposits for SVB and Signature, while also stepping in to backstop uninsured deposits for another mid-sized bank, First National. Swiss regulators brokered a deal for UBS to take over Credit Suisse and the Swiss central bank provided a loan of up to 100 billion francs ($109 billion) alongside another 100 billion francs from the Swiss government to shore up liquidity for the deal[1]. Central banks are desperate to head off crises of confidence that result in panic withdrawals. What they can’t do is stop nervous investors worrying that other financial institutions are sitting on toxic assets that are precariously exposed to one of the fastest interest rate tightening cycles in history.

OFXpert, Isaac Figueroa says that means global funds are seeking relative security in safe havens.

“There is a crisis of trust and that uncertainty creates volatility in currency markets,” Figueroa says. “The US dollar, the Swiss franc and the Japanese yen are safe haven currencies and as a result are benefiting from this uncertainty.”

As uncertainty circles the banking system, sentiment switches from hopeful to risk-off

There is a common adage in the investment community that when the Federal Reserve starts to raise rates, things tend to break[2].

During the prolonged period of ultra-low interest rates where money was cheap, and easy to come by, investments didn’t have to clear a very high bar to get the green light. Facing low returns, investors chased growth into riskier and riskier assets.

Take venture capital, a major originator of deposits for Silicon Valley Bank, for instance. The sector went hypergrowth during the Covid stimulus boom, nearly tripling the amount of funds it raised from $US60 billion in 2018 to $162 billion in 2022. Not only did that wave of money controlled by VCs lead to higher and higher valuations for the startups themselves, but more investment houses taking stakes in early-stage, mostly unproven business models.

As interest rates rose, those startup valuations slid dramatically and raising new capital became much harder as investors preferred the safer returns of government bonds. Now many investors are sitting on capital losses that they cannot exit.

That’s just one snapshot of one part of the investment landscape, and the venture capital universe is relatively transparent. The great unknown is the many complicated and exotic deals that counterparties entered into when times were good, but may be disastrous now that the world has changed.

“There is a lack of trust in the markets,” Figueroa says. It will likely stay quiet until we know who is the next business in the news to be exposed.”

There is a lack of trust in the markets, Figueroa says. It will likely stay quiet until we know who is the next business in the news to be exposed.

Businesses are being exposed at the fastest rate since the global financial crisis with Standard & Poor’s reporting that corporate defaults in the year to date are up significantly. In the United States, particularly, corporate defaults are 2.5 times higher than they were a year ago[3].

That’s also the case in countries such as Australia which has a seen a wave of collapses in the building industry, exacerbated by banks pulling back the amount they are willing to lend as funds become more expensive and bankers themselves become more conservative[4].

Extrapolate that across the global economy and you have conditions for low growth and limited economic expansion. Funding for major projects becomes tighter, so demand for goods goes down. Investors prefer safe havens for their cash, as pointed out by Figueroa, but it also means that so-called growth or commodity currencies will also perform poorly.

“Until this banking crisis is over, we won’t see the Aussie, kiwi or Canadian dollar going higher,” Figueroa says. “If you hear the major asset managers on the news they are very pessimistic. Everyone is in cash, and Americans, for instance, don’t want Aussie dollars.”

Not all safe havens are equal

Ordinarily the US dollar would be the key beneficiary of a switch to safe haven currencies. But the fundamentals are against that happening, Figueroa says. Even before the bank failures hit the headlines, investors were turning away from the greenback as it appears they are at, or nearing the top of their interest rate cycle.

The USD had been the strongest performing currency last year, as it was one of the first to start tightening, and it tightened particularly aggressively. Expectations are those rate rises are coming to an end.

So if we have more bad news, the Japanese Yen looks more likely a haven, as does the Swiss Franc

“The US dollar is not going higher now because no-one is expecting the US Federal Reserve to increase rates. This perception of the Fed being done with rate rises happened before SVB, so it has not rallied as much since then,” Figueroa explains.

“So if we have more bad news, the Japanese Yen looks more likely a haven, as does the Swiss Franc.”

Euro to outperform this year

The European Central Bank was one of the last institutions to raise interest rates, starting in July 2022 as opposed to the Fed’s hike in April. With inflation still high at 6.9%, it is well above the ECB’s target rate of 2%, and Figueroa says the market is still expecting the eurozone to have higher rates in December, in comparison to other jurisdictions where rate cuts are now becoming a possibility.

The region has had a scare with the Credit Suisse collapse but if there is not widespread contagion, the euro looks like a good bet for currency watchers.

“If there is another bank that gets into trouble, then the euro is going to fall, because the USD is more of a haven,” Figueroa says. “But once this banking crisis clears, the euro is going to be strong.”

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