Shares of German megabank Deutsche Bank slumped on world exchanges Friday as the cost of insuring its bonds against default rose sharply, in another sign global fears of a financial system crisis have not gone away.
The bank’s shares fell 14% on the German market while in the U.S., Dow Jones Industrial Average futures were down more than 300 points in premarket trading.
The concerns over the German bank follow the forced firesale of Swiss bank Credit Suisse to rival UBS, brokered by the Swiss government, less than a week ago and the failures of three U.S. banks. Though the reasons behind each bank’s problems were different, they broadly reflect weaknesses brought to the forefront by the rapid raising of interest rates by global central banks, including the Federal Reserve, and fears of a worldwide economic slowdown.
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The fear in the banking sector has spilled over to the bond market, where yields on U.S. Treasuries have tumbled recently as demand for them surged amid a flight to safety. Bond yields fall as prices rise. The yield on the 10-year Treasury was 3.31% early Friday morning; at the beginning of the month, it had gone above 4%.
The volatility in the markets reflects the delicate state the U.S. economy is in. On Wednesday, the Fed raised interest rates by a quarter point – less than had been expected as recently as a week before its meeting – as it battles inflation that is still running at levels twice its annual average target of 2%. But, at the same time, Fed Chairman Jerome Powell warned that a credit crunch from the banking crisis could slow the economy in the weeks to come.
At the same time, Treasury Secretary Janet Yellen was telling Congress that not all bank deposits were going to be protected, a statement she later amended to say the government would take “additional steps” if needed to address stability in the banking system.
The Dow fell more than 500 points on Wednesday. The sudden drop in bond yields also suggests that the market believes the next move from the Fed will be to cut rates to spur the economy should a recession occur.
The broader picture is one of markets and companies coming to grips with a systemic change to the pricing of money by central banks. For more than a decade, the global economy has feasted on a diet of cheap money, even in some cases of interest rates below zero, that encouraged risk and speculation. Prices of assets such as houses and stocks rose as people gambled that what they bought would increase in value.
Then came the COVID-19 pandemic and a massive bout of stimulus to the global economy. Banks and other financial companies found themselves flush with cash that they then put to use, often buying long-term government bonds that have now lost a lot of market value in the face of higher interest rates. As rumors of problems at banks such as Silicon Valley Bank materialized, depositors began taking their money out, prompting a run on the banks.
A rescue plan unveiled by the U.S. government on March 12 has seen banks borrow billions from the Fed, using their devalued government bonds as collateral, while depositors have been pulling billions out of regular checking and savings accounts and putting them in money market accounts at large banks and investment firms that pay much higher interest rates. More than $100 billion flowed into money market accounts in the week immediately following the collapse of SVB, the highest inflow since 1992.
Meanwhile, banks borrowed $53.7 billion from the Fed’s new program as of Wednesday, up from $11.9 billion the week before. And another Fed program designed to help shuttered banks saw borrowings rise to $179.8 billion from $142.8 billion a week earlier.
The volatility is likely to continue until markets see clarity from the Fed and other central banks on the path of interest rates and the overall health of the global banking system. Friday’s activity around Deutsche Bank signals that moment has not yet arrived.
