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Gold prices shot up earlier this week up two percent Breaking through the milestone of $2,000 per troy ounce. The data on the US economy that came out caused concern among investors. In addition, Jamie Dimon, CEO of the American investment bank JPMorgan Chase & Co., warned that the banking crisis is not over yet. Was the optimism on the stock market in recent weeks too premature?
On Tuesday, the three largest U.S. stock markets closed lower, after data on the U.S. economy came out pointing to a cooling economy. This raises the question of whether the FED, the US central bank, can still raise interest rates at the next interest rate decision to curb inflation.
We have on Holland Gold I've written before about the difficult situation central bankers are in right now. In Frankfurt, the European Central Bank (ECB) is constantly navigating between high inflation and the risk of a new crisis. Inflation is currently high, so raising interest rates seems like the right thing to do to cool the economy. But at the same time, sovereign debt has risen so high that such interest rate hikes could lead to financing problems in countries such as Italy and France. Real estate prices are also falling due to rising interest rates. If interest rates rise further, this could have an impact on financial stability.
In America, the Fed faces a similar dilemma. Inflation in the U.S. was still high in February six percent, while the target is set at two percent. While an additional interest rate hike could fight inflation, it could also create more difficulties for the U.S. economy. The Fed has a dual mandate and must not only ensure price stability, but also keep an eye on unemployment. Rising interest rates slow down economic growth and can be at the expense of jobs.
Inflation rates in America over the past three years (Source: Statista)
On Tuesday, it was revealed that the number of job openings in the U.S. had fallen to its lowest level in two years in February, according to the report Reuters. Although the labour market in America is still very tight, just like in the Netherlands, this may be a sign that the effects of the Fed's aggressive policy are being felt. In the space of a year, interest rates in America have risen by almost five percentage points. Also compared to previous periods of interest rate hikes, the policy of recent months has been very aggressive.
The labour market is still tight, but the reversal of the trend is a cause for concern (Source: Reuters)
In addition to bad news about the labor market, there is also concern about the declining demand for products produced in the U.S. The Factory Orders decreased in February for the Second month in a row. It indicates that companies are delaying spending and are concerned about the future. In February, new sales orders fell three percent year-on-year. In January, this was still more than two percent year-on-year. The Fed's aggressive policy is slowing down the demand for products. Many of these sell orders are normally financed with debt. With interest rates rising, these types of purchases are therefore becoming more expensive.
The Purchasing Managers' Index, an index of purchasing managers' confidence, also fell to its lowest level in three years in March. For the first time since 2009, all components of this index fell below 50. Indices below 50 are expected to see a decrease in activity, while indices above 50 are expected to see an increase in activity.
Bank stocks in particular fell on hard times this week. Bank of America's stock, for example, fell more than two percent on Tuesday. This happened after the warning from JPMorgan's CEO, Jamie Dimon. In a letter to his shareholders, Dimon indicated that the current banking crisis is still ongoing. Even when this crisis is over, the effects of this crisis will be felt for years to come, according to Dimon.
According to Dimon, the likelihood of a recession has increased in recent months. Last month, banks such as the Silicon Valley Bank in trouble. As in 2008, a lot of money is now flowing from small banks to the big banks and money market funds, which could put more small and medium-sized banks in difficulty. However, this crisis cannot be compared to the crisis of 2008. In 2008, large banks and insurers as well as normal households were affected. Now, according to Dimon, far fewer parties are directly affected by the current unrest.
The Dutch Central Bank (DNB) also sees not a great resemblance with 2008. According to DNB, we don't have to worry about Dutch banks. The Dutch Central Bank (DNB) considers it unlikely that banks in the Netherlands will end up in trouble en masse again. Not only do banks have more liquidity and capital, according to DNB, but the effects of a bank failure on other banks in 2008 were also not clear and we can now assess those risks much better.
In 2008, almost all banks were exposed to any risks at a particular bank through derivative contracts. Currently, a very large proportion of these types of contracts are routed through central counterparties, which has greatly reduced this risk, according to DNB.
Yet this is a different story than the one we hear from financial journalists like Arno Wellens. According to Wellens, a large part of the risks that banks run are hidden by derivatives. In the Podcast on the channel of Holland Gold he explained, among other things, the derivative contracts concluded with the Latvian bank Parex. According to Wellens, many risks can be hidden in this way and banks can be in worse shape than initially visible.
Since the turmoil in the banking sector in America, much of the money has been moved. For example, people took money out of small banks and deposited it in larger banks. However, some of the money has also been moved to the Money Market Funds. In America, it is easier and more common to put money in such money market funds. These funds pay higher interest rates and invest money in safe assets, such as government bonds.
The money that ends up in money market funds disappears from the banking system. Money market funds usually park excess money with the FED and not with commercial banks. The Financial Times recently wrote that this could cause problems. In the first weeks of March, $161 billion flowed out of the banking system. Most of this money flowed out of America's small banks.
The inflow and outflow of money into and out of money market funds (Source: Financial Times)
Analysts are concerned that these outflows from the banking sector will lead to less credit creation. If money flows out of the banks, it affects the amount of credit that banks are allowed to create. At present, bank interest rates are still lagging behind money market fund rates, but even if banks offer higher interest rates on deposits, it is quite possible that people do not yet have enough confidence in the banking sector to take money out of money market funds and return it to the banks.
Investor concerns drove up the price of gold. Gold ended two percent higher on Tuesday. The gold price thus reached its highest point in twelve months. According to Kitco Can a all time high will be reached this year if there are more signs pointing to a recession. Later this year, the Fed could cut interest rates to stimulate the economy again. Time will tell how the gold price will develop this year, but the outlook for precious metals looks favorable for the time being.
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