The global financial system isn’t out of the woods just yet, but so far, the stress in the banking sector looks to be contained, while the market’s outlook for interest rates has shifted sharply, says TD Economics.
In a new report, the bank’s economists said that financial system stress represents an important downside risk to the economic outlook, with tighter credit conditions, alongside more restrictive monetary policy, weighing on growth prospects.
“Should it persist or worsen, it is likely to translate into meaningfully weaker spending and investment in an economy that was already expected to slow under the weight of high interest rates,” the report noted.
Yet, for now, regulators’ efforts to address stresses at specific banks have seemingly averted a broader crisis, it said.
“While we have seen worries shift to new banks in both the U.S. and Europe, and spreads of the lowest rated credits have widened, the financial market reaction does not reflect a systemic loss of confidence,” it said.
Compared with events such as the global financial crisis, and even Russia’s invasion of Ukraine, market volatility has remained relatively subdued, TD said.
“In terms of broad market impact, the overall equity market is still in positive territory over 2023,” the report said, noting that, while the S&P 500 is down by 5% from its peak in early February, it remains up by 4% on the year.
Similarly, the Euro STOXX index is still up 7.8% on the year, albeit down 4.5% from its highs.
The biggest effect so far has been on the bond markets’ expectations for monetary policy, the report noted.
“Markets are now firmly priced for over 75 [basis points] in rate cuts over the next year, causing Treasury yields to fall precipitously,” it said.
“While no one knows what will happen next, we will be closely monitoring the spread of the current stress, looking for signs of improvement or deterioration as key to the evolution of the economic outlook,” TD concluded.