There Is No Neutral Option Any More

By Benjamin Picton, Senior Strategist at Rabobank

The Neutral Option

So, the Swiss government has brokered a shotgun wedding for Credit Suisse (CS) and UBS: laws are to be changed to get the ring on the finger without putting it to a vote of UBS shareholders. The sticker price is CHF3bn according to Bloomberg, a substantial haircut to CS’s CHF7.4bn market cap when the market closed Friday. Regulators had repeatedly pointed out that CS was well capitalized and enjoyed strong liquidity coverage (even more so after the central bank facility was provided): if so, why was the large discount applied to the value of their equity? Nobody from either side is likely to be dancing at this wedding.

Subsuming CS into UBS raises the risk that instead of healing any sickness, the deal could transfer it to a larger host. Indeed, do the math on the two combined asset bases ($575bn + $1.1trn) compared to the Swiss economy. If a well-capitalised institution with more than $500bn in assets and central bank liquidity backstops was not sufficient to withstand a brief financial panic, will an asset base of 3x prove more resilient? Might the Swiss government want to be kept in the loop about strategic business decisions being taken as a logical result? Does that change political-economy a little? Is there still a neutral option?

Moreover, over the weekend, US mid-sized banks reportedly demanded a two-year total deposit insurance scheme from the FDIC, and warned if it doesn’t arrive there may lots more shotgun weddings… or shotguns. Reuters also reported “at least two” major European banks are examining scenarios of contagion and are looking to regulators, the ECB, and the Fed for support. 

So, here’s the cavalry: on Sunday, the Fed and five other central banks (ECB, SNB, BOE, BOJ and BOC – but note no EM) announced coordinated shifts in the frequency of dollar swap lines from weekly to daily: this is action only usually seen in a crisis. The week ahead looks a movable feast already, but it seems a safe bet that further central bank intervention is on the cards: and further changes in the global financial architecture, with a larger role for government/regulators(?) On which note, Hal Brands on Bloomberg and Defence One magazine both argue that SVB is US national security too, and the Pentagon has been paying close attention. There’s no neutral option there, it seems.

Whether this all remains a liquidity issue or instead metastasizes remains to be seen. For the moment, our Fed watcher Philip Marey still expects the FOMC will hold the line and raise rates by 25bps this week. However, there’s clearly a tension between the Fed’s price stability mandate and the need to ensure the stability of the banking system – and the national security issue of the global role of US dollar, which remains king in some markets as we see, but where the backdrop is increasingly Robespierre in others. Again, no neutrality anymore.

Especially as the International Criminal Court (ICC) on Saturday issued an arrest warrant for Putin, indicting him for war crimes in directing the abduction of hundreds of Ukrainian children by invading Russian troops. To say that this makes any peace negotiations more difficult is an understatement.

Of course, arrest warrants issued in the Hague are little more than an annoyance for Putin as he prepares to welcome his Chinese counterpart to Moscow today. Markets will be looking to see if they build on their ‘no limits’ partnership declared in February of last year: any Chinese pledge of military support to Russia would toxic for the US and EU, as such accusations already swirl. However, Xi is reportedly interested in brokering a peace deal in Ukraine following his success in fostering détente between Iran and Saudi Arabia – that as Poland provides up to 19 MiG-29 fighter jets to Kyiv. If so, what will Xi propose to Putin and Zelenskiy? Can neutrality be shown?

Meanwhile, critics of former US President Donald Trump’s who accuse him of being too close to Putin can bask in the news that The Don expects to be arrested on Tuesday in relation to a case brought by the Manhattan District Attorney’s office. Stitching parts of law into new cloth, according to legal experts such as Dershowitz and Turley, the DA will reportedly argue Trump contravened campaign finance laws by directing his former attorney to make a payment to former adult film star Stormy Daniels in return for her silence over an alleged affair with Trump in the mid-2000s. The salacious scuttlebutt aside, an arrest promises to be an incendiary event should it come to pass. Trump has already encouraged his supporters to protest on social media, drawing comparisons to the leadup to the January 6 Capitol riots. More broadly, a criminal indictment is likely to strengthen Trump and Putin’s political capital as perceived victims of D.C. conspiracies.

FX markets showed some initial enthusiasm this morning, with USD/JPY rallying up to 132.50, but this is now well off the highs and dealing just above the Friday close at time of writing; US Treasury yields were also little changed after an initial move higher. It seems that the half-life on positive risk sentiment is troublingly short. Understandably so, trying to be neutral.