Friday Wrap-Up (10 March)

(Maksymilian Mucha - Investment Director of UCLIF & Lead Editor)

Welcome to the Friday Wrap-Up, our weekly summary of events from the financial world that have had the greatest impact across asset classes. This week the main focus was on the failure of the SBV, however, we also cover the lastest NFP and monthly developments in Politics & Geopolitics. So what's moving markets?

Markets

In the US equities,?S&P 500?plunged?-4.55%?while?DJIA?was down?-4.44%. This Friday the financial markets were shaken by the shut-down of the Silicon Valley Bank by the Federal Deposit Insurance Corporation after $42 billion worth of deposits was withdrawn overnight. This impacted the entire financial industry, with S&P Banks Select Industry Index losing -14.26% in one week. Moreover, Friday was also the release-day of the NFP data, which showed that the US economy added 311,000 new jobs in February vs. 205,000 expected, down from elevated 504,000 last month. On the other hand, the unemployment rate in February rose to 3.6% compared to 3.4% expected and previously. As a consequence, US 10y Treasury?yield was down -25bp?to?3.71%?this week.

In Europe, the?FTSE 100?sold off?-2.50%?and?EURO STOXX 600?declined?-2.26%. Eurozone Retail Sales was up 0.3% MoM in January, up from a -1.7% decline in December, however, still below the expectation of 1.0%. UK 10y Gilts yield?declined?-22bp?to?3.64%, while?German 10y Bunds yield?were also down?-22bp to?2.50%.

In Asia, the?Nikkei 225?was up?0.78% while the?Hang Seng?decreased?-6.07% after disappointing Chinese trade figures and global risk aversion following the SBV insolvency.

Monthly Summary

Politics & Geopolitics (Michael Best)

UK and EU have resumed talks over regulatory cooperation in financial services. However, it is unlikely that this will result in near-term changes on access or cooperation. The UK stock market has declined over the past two decades, and policymakers have yet to make progress on more fundamental reforms such as capital markets and pensions, which are largely domestic in nature (FT ). The UK Capital Markets Industry Taskforce (CMIT) has suggested that pension fund allocations return to the 25% level they were at in 2007, which could generate between ￡847bn and ￡920bn of pension fund and insurer money (FT ). Harbour Energy, the UK's largest oil and gas producer in the North Sea, will shift investments overseas following a $1.5bn windfall tax hit, which contributed to a collapse in profit from $101m in 2021 to $8m in 2022. The tax, introduced last year, resulted in a non-cash deferred tax charge. Harbour has been one of the most vocal critics of the UK windfall tax, while BP and Shell have reported record profits (FT ).

The EU is considering joint maritime patrols and naval exercises to protect marine infrastructure from Russian spy ships. An updated maritime strategy calls for an annual EU naval exercise, better coordination between member states, increased satellite monitoring, and intelligence sharing. The strategy warns of mounting evidence of Russian activity around offshore wind farms, gas drilling platforms, and telecommunications cables. Floating gas storage and regasification units were highlighted as potential targets, and the plan includes proposals to tackle unexploded ordnance and mines at sea (FT ).

Chinese President Xi Jinping is launching one of the biggest reforms of the state apparatus in years to overhaul supervision of the financial system and boost science and technology to catch up with the West. The measures include establishing a new financial regulatory commission, reorganising the science and technology ministry, and creating a department to oversee China’s vast trove of data. The reforms are aimed at building up China's semiconductor industry and creating a "common prosperity" political economic model. The country will also create a National Data Bureau to oversee and protect its data (FT ). Taiwan has deepened ties with the US, Japan, and central and eastern European countries, despite these nations not formally recognizing the government in Taipei. The country's increasing tensions with China have intensified the US-China relationship (Nikkei Asia ). The threat of China invading Taiwan has moved to the centre of global money managers' risk radars and is being factored into their investment decisions (Reuters ). Separately, China has secured its grip on proposed offshore listings that will favour Hong Kong and domestic Chinese markets over Wall Street. The new rules provide the first unified regime for vetting and keeping tabs on companies that float abroad (FT ).

Democratic senators Joe Manchin and Jon Tester have sided with Republican lawmakers to roll back a US labour department rule that allows fund managers to consider environmental, social, and governance factors in their investment decisions. This marks a significant challenge for President Joe Biden's party, with Republicans making opposition to ESG a key pillar of their pitch to voters, and may result in the first veto of his presidency (FT ). Biden made a surprise visit to Kyiv on the 20th of February, demonstrating his support for the Ukrainian cause. US public support for Ukraine is, however, falling (Pew Research ).?

Russia will freeze participation in the New Start nuclear arms treaty, which limits the number of the US and Russia’s deployed strategic nuclear weapons (FT ). Russia's energy conflict with Ukraine has resulted in both sides realizing their hopes for a swift victory were futile. Russia believed its gas couldn't be replaced, but a mild winter and suppressed Chinese demand restored balance on the global gas market. Ukraine hoped cutting Russia off from western technologies, markets, and financial resources would weaken its neighbour, but that too has not happened. The conflict is now a war of attrition, with Russia hoping for a surge in demand and Europe diversifying its energy portfolio (FT ).

Equities

Healthcare?(Joshua Sim)

In healthcare news, pharmaceutical companies in the UK are pressuring the UK government to reduce levies on branded medicine sales. Under an agreement signed in 2019 with pharmaceutical companies to prevent drugs from becoming unaffordable, known as the Voluntary Scheme for Branded Medicines Pricing and Access (VPAS), the NHS has capped drug bill increases at 2% a year. Any additional revenues earned by pharma companies have to be returned at a clawback rate determined by the UK government. In 2023, the clawback rate is expected to be 26.3%, much higher than the 5-10% range from 2019 to 2021.??

At the expected clawback rate,? this will amount to almost 3.3 Billion of returned sales from pharmaceutical sales, up from 1.8 Billion and 0.6 Billion in 2021 and 2022 respectively. In response to this, Pharma giants Eli Lilly and Abbvie have pulled out of the agreement, while Bayer has cited that they are cutting jobs in Britain because of the levy. The pharmaceutical companies , represented by the Association of the British Pharmaceutical Industry, have warned that these levies could cost the UK up to 6 billion dollars in Pharmaceutical R&D investment. They have stated that an ideal clawback rate would be below 10% of revenues.

In the US, pharmaceutical giants have faced pressures from the US government to cut prices of essential drugs such as insulin. These pressures are set to increase further as Pharmaceutical heavyweight Eli Lilly has stepped forward and agreed to lower prices on their insulin drugs by 70%. This takes place amidst the backdrop of the Biden administration first introducing legislative price caps for insulin of $35 for a month for senior patients under government healthcare programs. The Biden administration has welcomed cuts by Eli Lilly, and have encouraged other pharmaceutical companies to follow in their footsteps. Based on the market’s reaction, Eli Lilly shareholders seem to be reassured by the CEO Dave Rick’s comments that the changes would not have an effect on sales guidance. They also have likely seen these changes as priced in, and see this as the acceleration of existing trends among insulin products.?On the other hand, given that Eli Lilly’s average costs for its insulin products is already below the $35 cap, these changes could possibly benefit Eli Lilly by helping them gain market share and grow the top-line.

In the last few months, obesity drugs have generated a lot of buzz, popularised by celebrity use, Most notably, Elon Musk, has swore by its effectiveness. These drugs include Wegovy and Ozempic, which use hormones to regulate appetite. The success of these drugs could signal a breakthrough in the treatment of obesity, an ailment that currently affects 650 million worldwide, and that is expected to affect half of Americans by 2030. The total addressable market is expected to reach $54 Billion in the next 7 years, with around 60% of the market coming from the United States alone. These trends are set to be a huge long term catalyst for Danish Drugmaker Norvo Nordisk, a key player in this industry, who also manufactures Wegovy and Ozempic. They have been able to generate $2.4 billion in sales for these drugs in 2022. Driven by this, shares of the company are up 40% in the past year. The success of these drugs could signal a breakthrough in the treatment of obesity, an ailment that currently affects 650 million worldwide, and that is expected to affect half of Americans by 2030. The total addressable market is expected to reach $54 Billion in the next 7 years, with around 60% of the market coming from the United States alone.

Financial Institutions?(Gauri Varma)

This week in financial institutions, we have seen disaster strike UK tech companies amidst the Silicon Valley Bank collapse. The UK chancellor is preparing to provide a cash lifeline to tech businesses in the next week due to the risk posed to tech and life science companies who had used the UK arm of SVB, as they could struggle to pay wages and bills next week. SVB UK had 3,300 UK clients ranging from start-ups to venture backed companies and funds. Tech companies risk losing their deposits of above ￡85,000. Silicon Valley Bank was a crucial financial institutions for start ups, allowing them to secure a relationship with a large and established bank and gain funding. Facing a bank run, SVB sold $20bn in securities to offset the steep drop in deposits. Investors dumped their SVB stock, crashing the market value from $44bn 18 months earlier to $7bn now. Customers had initiated withdrawals of a quarter of the bank’s total deposits in just one day, and SVB was unable to meet their requests. SVB was declared insolvent. Many tech companies now face uncertainty about their bank accounts and business operations. The biggest risk SVB faced, according to a senior bank executive at SVB, was catering to a tightly knit group of investors who exhibit herd-like mentalities.?

The failure of SVB has had further impacts . One such example would be on Circle, the operator of one of the world’s largest stablecoins. $3.3bn of their reserves were in SVB, triggering a fall in the value of its USDC token. SVB’s collapse is the second largest bank failure in US history, and has now served blows to the crypto market.

Industrials & Materials (Oliver Andrews)

During the last 7 days, the Industrials and Materials sectors have experienced significant drops of 5.2% and 7.9% respectively. The main driver of this decline is attributed to the recent comments made by Fed Chair Jerome Powell on Tuesday, wherein he expressed a more Hawkish stance. Specifically, Powell indicated that if economic data suggests a need for faster tightening, they are willing to increase the pace of rate hikes. The Industrials and Materials sectors are particularly sensitive to interest rate expectations due to their cyclical nature. Their performance is closely tied to the overall state of the economy, and an increase in interest rates can lead to reduced investment in business operations, which in turn can lead to decreased demand for goods, capital, and raw materials. Powell also noted that interest rates are likely to be higher than previously anticipated in the long run. This sentiment further fuelled concerns among investors, contributing to the recent decline in the Industrials and Materials sectors.

The Aukus defence pact is a significant development in the Aerospace and Defence sector. The agreement involves the provision of nuclear-powered submarines to Australia and promises to create jobs and facilitate technology-sharing among the US, UK, and Australia for several decades. Delivering on the pact poses immense industrial and operational challenges, with all three countries needing to invest heavily in upgrading their defence industrial base. The project's cost is estimated to be as high as $125bn to build and supply at least eight submarines over 30 years. This program could offer a lifeline to Britain's submarine enterprise, which has a history of cost overruns and delays. The Aukus pact will also create opportunities for defence contractors. BAE Systems and Rolls-Royce have been involved in talks on the UK side, while General Dynamics and Westinghouse have been involved from the US. Rolls-Royce is expected to provide the propulsion system. However, the potential profits will take time to materialize, and securing lead positions will be crucial for the companies involved. The transfer of technology under the International Traffic in Arms Regulations and the NoForn classification that restricts information sharing with non-US nationals remain significant obstacles to the deal.

Fixed Income

Rates (Mira Kwan)

The Fed stated that they were prepared to raise the interest rate hikes back to a 50bps increase in March, with the likelihood up to 80%, calculated based on Fed fund futures. However, this likelihood had dropped to 28% by Friday night, tilting towards a likely 25bps increase. This may have been due to the increase in unemployment rate which hasn’t moved up since last October. Although 311,000 jobs were added in February in the US, which is higher than the expectation, it is confusing report, as it shows that average hourly earnings increased by 0.2%, 0.1% less than expectations, which hints at less pressure from wages on inflation. It may be the case that job reports are weaker than it seems; while headline numbers seem strong, wage growth, average hourly earnings are convincing to the Fed that the March hike should continue to be 25bps. This is further supported by the 0.49% drop in the two year Treasury yield on Wednesday and 0.3% drop on Friday, which moves with interest rate expectations. The crypto market collapse which took down Silvergate and losses in venture capital also supports the Fed’s decision to tilt towards a 25bps rise.

Accelerating from 25bps to 50bps would signal too big of a deviation in the Fed policy, which would suggest that peak interest rates may go beyond the 5.3% currently priced in by markets. Investors now lower expectations for a 50bps hike in response to this jump in employment and cooling wages, and price in a 25bps hike.

Commodities

Oil, Gas & Precious Metals?(Sofia Buono)

Crude Oil

This week, the prices of oil have decreased by 1% to a two-week low. In particular, Brent futures ended the week trading at $81.59 per barrel, their lowest close since February 22, and U.S. West Texas Intermediate (WTI) crude futures settled at $75.72, their lowest close since February 27. In other words, the clouded global growth outlook has driven crude benchmarks down almost 5% this week. This phenomenon is the result of rampant worries that the U.S. Federal Reserve may go too far with its interest rate hikes to control inflation. This creates concerns over a possible economic recession as higher rates increase consumer borrowing costs, which could curb the demand for oil and drive down prices. OPEC Secretary-General Haitham Al-Ghais echoed such concerns stating that decreasing oil consumption in the US and Europe could threaten the market. Furthermore, if global economic growth slows down significantly, this could also lead to a broader decline in investor sentiment, which could weigh on oil prices further. Investors continue to assess the demand outlook in China, as the world’s top crude importer dismantled strict Covid curbs. The hope lies in higher Chinese demand to offset the concerns about a potential global recession.?

European Natural Gas:?

On Friday, European natural gas prices halted their protracted decline and soared 21% as protests in France closed four LNG terminals, all while cold weather gripped the northern fringes of the region. However, the cold snap is expected to persist only into next week, and milder temperatures are expected to return shortly. Morgan Stanley suggests that wholesale gas prices could be set to fall further in the coming months, as a strong pipeline of Liquefied Natural Gas (LNG) supplies could see Europe overstocking on gas during the summer. An oversupply of gas could lead to lower prices as the market becomes saturated with excess inventory. Currently, European storage levels are at 57%, a record high for this time of year. Overall, Dutch TTF, the European Benchmark, has rallied 17.5% on the week to €53.00/MWh.

Alternatives

Digital?(Marco Fontanesi)

On this week Friday wrap-up, we are focusing on the de-pegging of Oracle’s stablecoin USDC.?

During the night of Saturday, 11 March, the value of USDC, the famous US dollar stablecoin, lost up to 14% of its value, breaking away from the $1 value and falling as low as $0.86. At the moment, CoinMarketCap reports a value of $0.91.?

The news that triggered the stable's sales was that Circle, the issuer of USDCs, had some of the assets used as collateral for the peg in some of the banks that are at the centre of the financial maelstrom that is hitting the banking sector in the US these days.?

According to Circle's January reserves report, the company held about USD9.88 billion of cash on deposit with regulated banks to support USDC's value. According to Circle's 10 March website, cash deposits in reserves amounted to $11.1 billion.?

USDC's banking partners included Silicon Valley Bank (SBV) , the Californian bank that was taken over by regulators and closed on Friday, and SilverGate , the other bank that closed two days ago.

If you are interested in the consequences of this de-pegging, I recommend reading the following article in the Financial Times: “Circle’s stablecoin banked at SVB and guess what happened next ”.