Is it Bear Stearns all over again?
Following yesterday’s chaotic flows across many markets, with the most historic moves observed in the US 2-year yield and Fed Funds futures pricing the direction of future Fed rate decisions, we are observing a relief rally today. Equities are higher, several US financial institutions are up in pre-market, bonds are lower, interbank funding stress is coming down (see FRA-OIS spread below), VIX is coming down and the VIX forward curve is less inverted, and the USD is stronger. There is a sense today that the financial system suffered a shell shock but ultimately survived.
While risk is bouncing back it is worth noting that US financial conditions are not rebounding to the same degree. US financial conditions are as tight as back in early October, so all things being equal the S&P 500 Index should be lower reflecting these tighter conditions. The fact that US equities are not reacting to the tighter financial conditions are either 1) short-term flows and trading are dominating the price action which is today betting on mean reversion, or 2) that equity investors are betting that financial conditions will quickly loosen again. Our view is that this event did happen without longer lasting effects in the system and changing market behaviour.
The downfall of Bear Stearns certainly comes to mind observing the markets response. It all started with two failed Bear Stearns credit hedge funds failing due to losing 90% of their value in July 2007. The market got initially spooked but carried on to new highs. The problems came back and on 14 March 2008, exactly 15 years ago, after initially been given a loan from the US government the investment bank was taken over by JPMorgan Chase. The market initially celebrated by the swift rescue and solution to the problem with equities rally over the next two months. Eventually the problems snowballed into a systemic risk that ended with the Great Financial Crisis.