Written by Worries about US regional banks set off risk aversion
Equity markets turned into a sea of red on Friday amid signs of trouble within the regional banking sector in the United States after two lenders disclosed exposure to bad loans. Zions Bank and Western Alliance Bank saw their share prices dive by more than 10% on Thursday, even though the risks of the two banks collapsing are seen as quite low right now.
Nevertheless, concerns about lending standards have brought back memories of the mini-banking crisis in March 2023, which prompted the Fed to provide emergency funding to the sector. The market reaction may be overblown slightly as the disclosures come days after an auto lender and an auto-parts supplier filed for bankruptcy due to fraudulent activities, drawing the attention of JPMorgan CEO Jamie Dimon, who warned there could be other ‘cockroaches’ about.
One big difference, however, compared with the 2023 turmoil is that, back then, the Fed was in the midst of hiking interest rates, whereas this time round, borrowing costs are coming down. But that’s not to say there isn’t a danger of a worsening panic in the markets even if contagion is contained.
Investors are grappling with a host of uncertainties at the moment. In particular, the protracted government shutdown in the US and renewed trade tensions between Washington and Beijing are a source of great unease in the markets. And when stock markets are rallying to all-time highs against such a backdrop, it won’t take much to trigger a major correction.
US yields sink, pressuring the dollar
Fears of an unfolding crisis are certainly being reflected in Fed funds futures. Investors have started to price a small probability of a larger 50-basis point rate cut at the Fed’s October meeting, with further reductions seen in both December and January.
Combined with the latest flight to safety, the growing bets of a more aggressive Fed are wreaking havoc on Treasury yields, as well as sovereign bond yields globally. The US two-year yield has fallen to its lowest since September 2022, while the 10-year has slumped towards the post-Liberation Day lows.
Unsurprisingly, the US dollar is headed for weekly losses, with its rebound from the September lows now under threat.
Yen and franc shine
On the other hand, the dollar’s woes and jitters about US banks have brought some relief to the struggling yen, amid the ongoing political drama in Japan. The safe-haven Swiss franc is also in demand today.
Japan’s parliament will likely hold a vote on October 21 to decide whether to elect Sanae Takaichi – the new LDP leader – as prime minister. The LDP party is due to hold a second round of talks with the smaller Nippon Ishin party on forming a coalition. If the talks fail, the opposition CDP party could attempt to nominate a different candidate for prime minister.
Without an end to the political stalemate, it’s unclear whether the Bank of Japan would go ahead and raise interest rates later this month, although Governor Ueda isn’t ruling it out and this is offering an additional boost to the yen today.
Focus on earnings as shutdown drags on
On Wall Street, e-mini futures point to further declines for the major indices today, but the size of the losses is more indicative of a healthy pullback rather than a major panic. If US markets manage to bounce back later today, there’s still a chance of ending the week higher.
A solid set of earnings from the major Wall Street banks this week suggests the US economy remains in good shape, while the flurry of deals within the AI sector is fuelling tech stocks. International chipmakers ASML and TSMC have eased concerns about waning demand for AI chips, setting the stage for positive earnings by US tech giants over the next few weeks.
On the negative side, the government shutdown is certain to drag into next week after a 10th Senate vote failed on Thursday. The Republicans are offering to hold a vote on extending the contentious Affordable Care Act subsidies, but the Democrats want further guarantees on such a vote taking place before climbing down and accepting the Republican funding bill.
In the meantime, the Fed’s Beige Book warned of a possible spike in layoffs in the labour market and weaker consumer spending, potentially swaying more Fed policymakers to support steeper rate cuts in the absence of official jobs data.
Easing geopolitical risks weigh on oil, but gold and silver surge
In commodities, the risk-off mood is propelling gold and silver to new record highs. The former smashed above the $4,300/oz level on Thursday, just a day after breaking above $4,200/oz, while the latter has skyrocketed above $54/oz.
Signs that Russia’s President Putin may be ready to start direct dialogue with Ukraine on ending the war haven’t made much of a dent in the precious metals. Putin and President Trump have agreed to meet in Hungary “hopefully soon” after the two leaders held a phone call yesterday.
Putin’s change of heart could be down to the renewed pressure by the White House on other countries to stop buying Russian oil. India this week agreed to halt its purchases of Russian oil. But possibly a bigger reason is that the US might allow Ukraine to use long-range Tomahawk missiles against Russia when President Zelensky meets with Trump in the White House later today.
The boost to oil futures from reduced Russian supply was short-lived, however, with the broader risk aversion weighing on prices and pulling WTI futures towards the May lows.
By XM.com
