Bonds Surge as Fears Over US Bank Portfolios Spur Haven Demand

(Bloomberg) — Government bonds surged and stocks slid as signs of distress at a Californian lender spurred broader worries over the US banking sector’s debt holdings.

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US and European bond yields tumbled to their lowest in weeks as traders bet any turmoil at banks could reduce the ability of the Federal Reserve to keep hiking interest rates. The Stoxx Europe 600 Index slumped the most since December, led by banking shares.

Markets are jittery on the potential fallout from Silicon Valley Bank — a small technology-focused lender — which has suffered significant losses on a portfolio including US Treasuries and mortgage-backed securities. That sparked a selloff in US stocks Thursday, with investors now turning their attention to risks that may lurk in other financial institutions after the Fed’s steep rate hikes.

“Broader banking concerns may put question marks behind the pace the Fed is able to raise interest rates,” said Christoph Rieger, head of fixed-rate strategy at Commerzbank AG.

Traders pared wagers on the scope for further Fed tightening, which has eroded the value of holding Treasuries. The odds of a half-point increase this month have fallen to 50% compared to 75% previously. Money markets are now pricing a total of 91 basis points of hikes by July, compared to 112 basis points on Wednesday.

That drove down 10-year Treasury yields by as much as 11 basis points to a three-week low of 3.80%. German 10-year government borrowing costs also slid as much as 17 basis points as markets eased wagers for a peak in European Central Bank’s terminal rate to below 4% for the first time this month.

Story continues

One Bank Folds, Another Wobbles and Wall Street Ponders a Crisis

Adding to the souring sentiment was Silvergate Capital Corp., which said it plans to wind down operations and liquidate after the crypto industry’s meltdown sapped the company’s financial strength. US equity futures pointed to further market losses on Friday.

“The setup from the US makes for a gloomy trading start this Friday. Investors have been shown in a very clear way what the rate hikes can do to the economy,” said Frank Sohlleder, a market analyst for ActivTrades.

However, Oliver Scharping, a portfolio manager at Bantleon, thinks there are only limited cross-reads for European banks. If the sector continues to remain under pressure in sympathy over the next few sessions, contagion could be an opportunity to add exposure, he said.

“While I’m getting arguably some Bear Stearns ‘08 vibes and liquidity is disappearing across the board, it doesn’t feel like a systemic issue yet,” he said.

The issues within the US banking sector have emerged just ahead of Friday’s monthly jobs report, a key figure in the outlook for further rate increases. Economists project a 225,000 increase in February payrolls, about half January’s blockbuster pace, and a softer number could further tilt expectations back to a quarter-point Fed hike.

“The ongoing concerns over SVB would set a fragile stage for the important NFP release today,” said Mohit Kumar, rates strategist at Jefferies International. “A higher than expected number would exaggerate the market reaction in equities; while a weaker number would exaggerate the market reaction in rates.”

Far-Reaching Impact

A measure of European banking stress in funding markets rose to the most since April 2020. The impact is also being seen in credit markets, where the cost of protection against defaults by European companies recorded its biggest intraday jump this year.

Insuring a €10 million ($10.6 million) basket of junk bonds for five years now costs about €418,000 annually from under €400,000 at close of business on Thursday. Safeguarding baskets of bank bonds is also getting more expensive.

The subordinated financial sector is the only part of the euro-denominated high-grade market where risk premiums are widening on Friday morning, based on data compiled by Bloomberg.

Meanwhile, most contingent convertible bonds, the riskiest type of debt issued by European lenders, are suffering price drops. A Swiss franc-denominated note by Credit Suisse Group AG leads losses with a 0.9 point drop to 72.3 percent of face value.

“By exposing its weakness, SVB has somewhat opened Pandora’s box,” Arnaud Cayla, deputy CEO at Cholet Dupont Asset Management, told clients in a note.

–With assistance from James Hirai, Tasos Vossos, Ksenia Galouchko and Julien Ponthus.

(Updates throughout.)

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