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March
27
2023

A Matter Of Trust
Benjamin Picton

“I’ve lived long enough to have learned,
The closer you get to the fire the more you get burned,
But that won’t happen to us,
‘Cause it’s always been a matter of trust”  – Billy Joel

So we made it through a Friday evening without a bank collapse. This obviated the need for another weekend of regulatory scrambling, but if the price action is anything to go by we’re not out of the woods just yet. European bank shares took another dive on Friday after Deutsche Bank called a tier 2 bond and lit the fuse on more selling. The decision makers at Deutsche must have thought that early repayment would engender confidence. But this market is suspicious of promises, and promise-makers. Consequently, DB credit default swaps blew out and the stock sold off by more than 8%.

Deutsche could credibly claim that they are a bank more sinned against than sinning. As Paul van der Westhuizen, our Senior Financials Analyst, points out, DB has a strong profit outlook, whereas Credit Suisse didn’t. Capital and liquidity buffers are also very strong, and as a globally-systemic bank, there is little doubt that regulators and the German government would stand behind it. In short, there is no serious question over solvency or even liquidity. But banking is a trust game, and trust is hard to come by at the moment.

“It’s hard when you’re always afraid,
You just recover when another belief is betrayed,
So break my heart if you must,
It’s a matter of trust.”

Despite markets ending the week in a state of comparative calm, US authorities haven’t been idle. Data published over the weekend showed that an unknown central bank tapped the FIMA repo facility for $60bn worth of dollar liquidity last week. That is the maximum available, and there are only 23 countries with US Treasury exposures exceeding that figure, many of whom have Fed swap lines. Given that the FIMA liquidity is comparatively expensive (~20bps above market), the numbers were enough to raise some eyebrows and spark speculation about who done it. Could it be Germany? Might it have been China? And why?

Bloomberg reports that regulators are considering the expansion of emergency lending facilities to provide more support to embattled banks like First Republic. This follows confusion last week about whether or not the Biden administration would seek to extend deposit insurance to cover all deposits, rather than just up to the legislated $250,000 threshold. Treasury Secretary Yellen closed the week with an ambiguous promise to do more to support the banking system, if warranted.

Given the turbulence being experienced by otherwise healthy banks in Europe, it seems a safe bet that further steps will indeed be taken. We could learn more about what those steps might look like on Wednesday when the Fed’s Vice Chair of Supervision, Michael Barr, testifies to congress. Blanket deposit guarantees could be in the offing, but that would mean that the US government would be signing on to an $18 trillion contingent liability, backstopped by the FDIC’s $120 billion (with a ‘b’) balance sheet. Regulators have assured us that the taxpayer won’t wear the cost of depositor bailouts, but the math here is Herculean. I guess it’s just a matter of trust.

“Some love is just a lie of the soul,
A constant battle for the ultimate state of control,
After you’ve heard lie upon lie,
There can hardly be a question of why,”

Switching gears to geopolitics, Sweden, Norway, Denmark and Finland have issued a joint declaration of intent to integrate their national air forces into a single fighting unit. DefenceNews.com likens the move to the creation of a ‘mini NATO’. In effect, the move creates a reconstituted Kalmar Union (for defence purposes, at least), and highlights the realpolitik thinking of European states close to the Russian border. Clearly, there isn’t a great deal of trust there. In a similar vein, Polish PM Morawiecki criticised Germany Friday for not doing enough to support Ukraine. He also suggested NATO should ramp up defence spending to 3% of GDP and accelerate the repurposing of frozen Russian assets to assist the Ukrainian war effort.

“This time you’ve got nothing to lose,
You can take it, you can leave it, whatever you choose,
I won’t hold back anything,
And I’ll walk away a fool or a King”

Striking a more sanguine tone, EU foreign policy chief Borrell just declared Xi’s recent meeting with Putin has reduced the risk of a nuclear incident. This apparently justifies another Franco-German push for the EU to build bridges with China --'to coax it away from Russia’-- despite Hal Brands arguing via Bloomberg that what the US and the EU faces is a de facto Sino-Russian alliance. As Xi departed Moscow last week, he observed to Putin that “now there are changes that have not happened in 100 years. When we are together, we drive these changes.” Putin’s response: “I agree”. But Poland and the Baltics aside, the EU apparently isn’t getting the message. Indeed, Russia over the weekend announced that it would be deploying tactical nuclear weapons to Belarus, Poland’s immediate neighbor.

Obviously many things are in an epochal flux, from banks to geopolitics to supply chains. The Brazilian presidential state visit to Beijing this week (with 240 business people) has had to be cancelled due to pneumonia. However, Lula is calling on China, not the US, to help develop a Brazilian chip industry. As this Daily has previously argued, the world is bifurcating, and the pressure to pick a side is intense.

Meanwhile, Israel is in chaos following PM Netanyahu’s firing of his defense minister after he called for a halt to polarizing reforms to the judicial system: an estimated 600-700,000 protestors were on the street last night (up to 7% of the population), and a general strike may be called starting today. Detractors are accusing Bibi of setting himself up as a dictator. Bibi, naturally, denies it.

Again, it’s all a matter of trust.

Ben Picton is Senior Macro Strategist for the RaboResearch Global Economics & Markets team in Sydney. He is responsible for providing strategic economic research for Australia and New Zealand including interest rates and economic projections. Ben also works closely with the Australian and New Zealand RaboResearch Food & Agribusiness team.

Before taking up the role as Senior Macro Strategist in 2023, Ben worked for more than seven years on the Sydney Markets desk. Here he has held a number of positions in derivative sales and trading, covering both the Wholesale and Country Banking client portfolios.

Ben holds a combined Bachelor of Business and Bachelor of Commerce from the University of Newcastle, and a Master of Economics from the University of Sydney.

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