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Week in Review: 24-28 July 2023

Summary and Commentary


In May, treasury Secretary Janet Yellen said that more mergers among midsize U.S. banks could be necessary after a series of bank failures. And she was right. This week, Banc of California and PacWest merged.

Still on the banking theme... The FED, the Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency all agreed to put the over 1000-page proposal out for public feedback, which the banking industry is already criticizing. The new rules would increase the level of capital that banks with at least $100 billion in assets would be required to hold (an additional two percentage points of capital, or an additional $2 of capital for every $100 of risk-weighted assets). Furthermore, banks would be required to factor in unrealized losses and gains on securities in their portfolios in the capital ratios. But smaller regional banks would be spared from these new rules - these changes would not have prevented the collapse of Silicon Valley Bank, Signature Bank or First Republic earlier this year. Some officials who voted against the new regulations within the FDIC and FED cited concerns that it could significantly constrain banks’ ability to lend to businesses and individuals. Some also expressed concerns that banks would pass on their higher capital costs to consumers in the form of higher fees to maintain their profit levels. 

The Federal Reserve raised the target range for the federal funds rate by 25bps to 5.25%-5.5% in July 2023, in line with market expectations. The European Central Bank raised interest rates by 25 basis points on Thursday, a ninth consecutive rate hike, saying inflation is still expected to remain too high for too long despite the recent slowdown. Future interest rate decisions will be made in a meeting-by-meeting approach, all done with fuzzy criteria and no clarity - typical of central banks.

The US economy expanded an annualized 2.4% QoQ in the second quarter of 2023 (advance estimate), higher than 2% in the previous period and way above market expectations of 1.8%. Is the economy still booming, or are these values incorrectly adjusted for inflation? The later is probably true. Let's take a look at the labor force productivity (output per hour). Nonfarm business sector labor productivity declined by 2.1% in the first quarter of 2023, and productivity has been experiencing a contraction for five consecutive quarters on a year-on-year basis, which marks the longest period of contraction since the series began in the first quarter of 1948. With productivity declining, earnings contracting and cost of financing on the rise, we can forecast that an unemployment rise is eminent and should be evident in economic data in the next quarters.

Over in Europe, the economy is clearly not booming. The economic sentiment indicator in the Euro Area declined for a third consecutive month to 94.5 in July 2023, the lowest reading since last October. Next week, the Euro Area GDP number will come out, and it should confirm the stagnation scenario that we have been seeing for the past year.

Regarding the financial markets, for the week, the main stock market indices are generally up, with the NASDAQ 100 gaining 2.1 %, the S&P500 up 1.0%, and the RUSSEL 2000 up 1.1%. Gold was flat and silver lost 1.0%. The barrel of WTI gained 5.0% this week (now at ~80 USD), while natural gas dropped slightly (2.7%). Bitcoin dropped slightly and is now at ~29400 USD.

The relative strength of the US dollar rised 0.6%, and bond yields were stable. The US bond yield is peaking at 5.5% in 6 months from now, and the 10-year yield now sits at 3.95 %. The yield curve remains inverted (a recession indicator).

Sources

https://www.reuters.com/markets/deals/banc-california-talks-buy-pacwest-bancorp-wsj-2023-07-25/

https://edition.cnn.com/2023/07/27/business/new-bank-regulation-capital-requirement/index.html

https://www.reuters.com/business/finance/us-regulators-unveil-plan-banks-build-cash-reserves-2023-07-27/

https://www.tradingeconomics.com


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