January to March 2023, the first quarter of the year, proved again to be turbulent, with numerous events impacting financial markets. Despite this, markets all-in-all generally attain positive returns over the period. January market performance was strong; however, due to the release of some hotter-than-expected inflation prints, markets turned in February and fears over a potential banking crisis in March hit market sentiment and financial stocks in particular. The S&P 500 rose +7.03% from 3,840 to 4,109, though also endured a drawdown of -7.75% in 6 weeks from the beginning of February to the middle of March before ending the month strongly. The FTSE 100 hit an all-time high on 20th February at 8,014 before falling -8.47% to 7,335 on 17th March, yet the index was also able to finish the quarter positively (+2.42%) due to a surge at the end of the month. On the continent, the S&P Euro Plus took the well-publicised struggles of their banking sector in their stride, achieving a significant increase of +9.64% from 2,053 to 2,250.
Towards the end of 2022, a series of positive inflation reports gave rise to the hope of a scenario of 'immaculate disinflation', in which inflation would reach the 2% target and normalise around this figure – something which would undoubtedly be a positive tailwind for markets over the medium-term, and saw January returns be universally positive for almost all asset classes. This optimism was short-lived, however, after several hotter-than-expected economic prints hit in February and March – most notably US inflation for the 12 months to January being 6.4% against expectations of 6.2%, and the UK print for February being 10.4% against 9.9% expected. Most economists are still predicting inflation to come down markedly over the next three quarters. However, expectations have shifted to one where inflation may remain 'stickier' than the levels that had been anticipated at the start of 2023.
To combat inflation, the most powerful tool at the disposal of central banks remains the setting of the base interest rate, which as of March currently stands at 5% for the US Federal Reserve, 4.25% for the Bank of England, and 3.5% for the European Central Bank. Though it is a potent tool, it is estimated that policy changes take around 12-24 months to feed into the real economy. There is, therefore, a degree of uncertainty surrounding the economic impact of both monetary policies, which may be agreed today, as well as importantly, changes that have already been made. March saw several alarming signs that the sharps interest rate hikes seen through 2022 may have had some unintended consequences – with news on Wednesday 8th March that Silvergate Capital, a crypto-focused bank, would cease operations and liquidate its assets, an event which coincided with Silicon Valley Bank (SVB) announcing it needed to raise $2bn in capital, and had been forced to sell its bond portfolio at a loss. The next couple of days saw a declaration from SVB's CEO Greg Becker for everyone to stay calm amid credit agency Moody's downgrading their bond credit rating – actions which promptly saw their share price plummet 60%, create panic, and see a run on the bank occur. The sheer amount of withdrawals caused the bank to fail, and by midday on Friday regulators had taken control.
SVB proved to be just the beginning of the turmoil for banking companies, with the New-York based Signature Bank also seeing a deluge of client withdrawals over the weekend and similarly prompting regulators to take over. To stem fears of contagion spreading through the market, the US Treasury, Federal Reserve and Federal Deposit Insurance Corporation (FDIC) penned a letter outlining actions they were taking to maintain confidence in the US banking system, amongst them the statement that depositors' money at the two failed institutions would be "made whole" – a move which appears to have quelled many of the market's worries.
The knock-on effects on capital adequacy of higher interest rates was not just a quirk of the US financial sector either, with European banks also requiring regulatory interventions in March. Specifically, perennial struggler Credit Suisse which has been a target of short sellers for some years was in a deal brokered by the Suisse Government, acquired by fellow Swiss banking heavyweight and rival UBS.
On a positive note, the UK did see some better than expected economic data come through during the quarter with GDP growth in the final quarter of 2022 being upgraded. In data released in January, the UK avoided a technical recession by the narrowest of margins (0.01%) though this was revised higher to 0.1% in March – and means the earliest the country can enter a recession is July due to the definition of a recession in the UK being two consecutive quarters of negative growth. It is a measure of the relative improvement in fortunes that in only November, Bank of England chair Andrew Bailey stated that the UK was 'already in recession', with a downturn predicted to last until mid-2024. There are of course, still huge hurdles to be overcome, especially with inflation currently at 10.4%, though there is optimism that it will still fall quickly in the second half of this year.