INSIGHT: Banking contagion threatens to spread, hit chemicals demand hard

NEW YORK (ICIS)–The failure of two sizeable banks (Silicon Valley Bank, Signature Bank) in the US and the crisis of confidence contagion spreading to other US regional banks and now European financial institutions threatens to significantly tighten lending conditions at the very least, further slowing economic growth and potentially tipping the US and European economies into recession.

The implications for the economically sensitive chemical industry are huge, as a major step down in GDP growth or a contraction would crater demand in an already weak environment.

The US Federal Reserve raised interest rates at a record pace through 2022 to tighten credit conditions and tamp down runaway inflation. The result has been a collapse in the value of long-term Treasurys and other debt like mortgage backed securities (MBS) that banks have on their books. If depositors withdraw their funds en masse as has been seen, banks must sell these securities at large losses to cover the outflows.

The Fed, Treasury and the FDIC (Federal Deposit Insurance Corp) stepped in on 12 March with a strong move to halt a run on regional banks, guaranteeing that customers at the two failed banks with deposits above the protected $250,000 threshold would be made whole.

The Fed also created a new lending facility where banks can pledge certain debt securities as collateral at par (face value), even as the value of those securities may be far lower. This is critical, as much of the debt securities on bank balance sheets have plunged in value with the Fed rate hikes.

The new lending facility – called the Bank Term Funding Program (BTFP) – is meant to provide banks with enough liquidity to cover any withdrawal requests, so they are not forced to dump these securities at huge losses.

Yet without an explicit guarantee that all uninsured bank deposits (those over $250,000) will be safe, it is hard not to believe large depositors would continue to take funds out of smaller banks, and into the ‘too big to fail’ ones.

In Congressional testimony on 16 March, Treasury Secretary Janet Yellen said uninsured deposits would only be covered if failure to do so would “create systemic risk and significant economic and financial consequences”.

The contagion is now spreading to Europe, with Credit Suisse at the epicentre. On the evening of 15 March, Switzerland’s central bank stepped in with a $54bn loan to Credit Suisse. European bank stocks had been falling sharply along with their US counterparts.

Meanwhile, the latest economic data from the US shows weakening consumer spending and inflation at the producer level. Retail sales fell 0.4% in February from the prior month while the Producer Price Index (PPI) fell 0.1%. Yet the key Consumer Price Index (CPI) was up 0.4% in February month on month and is up 6.0% year on year – still well above the Fed’s 2% inflation target.

For the upcoming Fed meeting on 21-22 March, expectations have swung from a 0.50 percentage point rate hike, to now 0.25 points or a pause. The 10-year Treasury yield has plunged from over 4% in early March, to below 3.6% in short order, reflecting expectations of a major growth slowdown.

The banking turmoil reduces the odds of a soft landing or mild recession, according to Kevin Swift, senior economist of global chemicals at ICIS.

ICIS expectations for US GDP growth are at around 0.4% in 2023 and 0.8% in 2024. Global GDP growth is forecast at 1.7% in 2023, rebounding to 2.8% in 2024.

PROSPECTS FOR US HOUSING SECTOR
The US housing sector, a key chemical end-market which has already been hit hard by higher interest rates, could see lending for projects tighten further.

“While financial system stress has recently reduced long-term interest rates, which will help housing demand in the coming weeks, the cost and availability of housing inventory remains a critical constraint for prospective home buyers,” said Robert Dietz, chief economist at the National Association of Home Builders (NAHB) on 15 March.

“And a follow-on effect of the pressure on regional banks, as well as continued Fed tightening, will be further constraints for acquisition, development and construction (AD&C) loans for builders across the nation,” he added.

Prior to the regional bank crisis, ICIS projected US housing starts to fall 20% in 2023 to 1.24m units.

AUTOMOTIVE HEADWINDS
Another key end-market for chemicals – automotive – could also see renewed headwinds as financing becomes challenged and consumers pull back from large purchases. Demand for engineering plastics, largely used in automotive, is under pressure.

“Demand for many engineering plastics is a dumpster fire further complicated by destocking activity. Q4 2022 demand for many converters was the lowest in almost 10 years,” said Ramesh Iyer, director, engineering plastics at Chemical Data (CDI).

“Incoming orders have improved. However, the confidence level on transactional activity is diminished as purchase orders keep getting postponed or cancelled,” he added.

GREEN INVESTMENTS UNDER THREAT
The banking turmoil also threatens funding for big green energy infrastructure and electric vehicle (EV) projects being incentivised by the $369bn US Inflation Reduction Act. While this provides significant funding in the form of tax credits and grants, external financing is still needed.

The IRA incentivises production of EVs and EV batteries, solar cells, wind turbines and infrastructure for hydrogen and carbon capture and storage (CCS). This, along with the CHIPS Act to revitalise semiconductor production, is meant to spur a renaissance in high-tech US manufacturing which will require massive volumes of chemicals.

Amid all the crosscurrents and uncertainty, one thing is clear. There will be no revival in US manufacturing without stability in the financial system.

Insight article by Joseph Chang

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