Last week, US rates underwent a dramatic about-face+ when the second-largest bank failure in the nation’s history compelled traders to rethink hawkish wagers on the outlook for the remainder of the Fed’s tightening cycle.
Terminal rate pricing receded rapidly and two-year yields plunged nearly 50bps in two days as SVB collapsed. The odds of a re-escalation to a 50bps hike cadence at this month’s FOMC meeting fell away.
On Sunday evening, following a decision by the Fed and Treasury to backstop uninsured deposits at SVB and Signature Bank, which was also closed, Goldman changed their call for the March FOMC meeting. They now expect a pause.
“In light of the stress in the banking system, we no longer expect the FOMC to deliver a rate hike at its next meeting,” Jan Hatzius wrote.
The bank’s forecast for hikes in May, June and July was unchanged, but Goldman said there’s now “considerable uncertainty about the path.”
Two additional excerpts from the bank’s note are below. They provide useful color for the measures adopted by Janet Yellen and Jerome Powell on Sunday.
The FDIC has used the ‘systemic risk exception’ (SRE) to protect uninsured depositors in two bank resolutions, Silicon Valley Bank and Signature Bank. In both cases, the costs not covered by the banks’ assets would be funded out of the FDIC’s Deposit Insurance Fund (DIF), which had a $125 billion balance as of Q4 2022. The SRE waives the requirement that FDIC resolution uses the method that is least costly to the DIF. This option is available to the FDIC if resolving a bank in the least costly method would have “serious adverse effects on economic conditions or financial stability.” The FDIC’s decision to make this designation should reduce the perceived risk of holding uninsured deposits in other institutions and is likely to be helpful in reducing deposit outflows. An open question is whether the FDIC would continue to address other institutions in the same manner if they are of smaller size than the two banks in question.
A key aspect of the [new Fed liquidity facility] is that the Fed would value collateral at par without the standard haircut the Fed applies in other programs. This will allow banks to fund potential deposit outflows without crystalizing losses on depreciated securities. The loans are made with “recourse beyond the pledged collateral to the eligible borrower” suggesting that the par valuation of the collateral would only become relevant if the borrowing institution lacks sufficient assets to repay the loan. The facility is backstopped with $25 billion from the Treasury’s Exchange Stabilization Fund, which has a net balance of $38 billion. The Fed has indicated that it “does not anticipate that it will be necessary to draw on these backstop funds” likely because of the full-recourse nature of the advances under the program.
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