Predictably given the circumstances, Monday was a market and media melee. I imagine every day this week will be a similarly disorganized affair.
As I mentioned Sunday evening, it’s obvious that US officials, regulators and many in the financial community believed the spark from the second-largest bank failure in US history did, in fact, have the potential to cause a conflagration. The FDIC, Fed and Treasury invoked the “systemic risk exception” to backstop depositors, and the Fed is determined to reduce the risk posed by unrealized losses on Treasurys and MBS parked on bank balance sheets.
During these sorts of episodes, it’s important to be judicious about where you get your information, because events like these create opportunities for politicians and also for charlatans and sundry “contrarians” to sow additional societal discord in the service of garnering attention for themselves.
With that in mind, note that the definition of “moral hazard” is: “Lack of incentive to guard against risk where one is protected from its consequences.” Virtually no one seeking to maximize public angst and rancor with abrasive moral hazard lectures Monday is affected in any material way by the generalized disaffection on Main Street. So, you could say such commentators have “a lack of incentive to guard against risk where one is protected from its consequences.”
In any event, the price action was dramatic. Two-year US yields plunged more than 50bps. Taken with the ~50bps drop seen late last week, things look quite a bit different than they did last Monday, to put it mildly.
For what it’s worth, the three-day rally at the front-end is the largest since Black Monday. German two-year yields were on track for their biggest two-session drop ever.
There was nothing in the way of consensus about what recent events mean for the Fed’s hiking cycle. Goldman now expects a pause at this month’s meeting, and while the bank still sees hikes in May, June and July, Jan Hatzius conceded there’s “considerable uncertainty about the path.” Others are sticking with their Fed calls — for now anyway.
Needless to say, terminal rate expectations continued to recede on Monday, and “recede” is an understatement. Over three days, peak-rate pricing dropped more than 90bps.
At one juncture, pricing suggested some chance that the hiking cycle is over. A pause next week was priced as a coin toss.
Suffice to say the March SEP is now totally up in the air. As noted in the weekly+, if things don’t calm down by March 22, the combination of aggressive dots and any upward tweaks to the Fed’s inflation forecasts could be highly destabilizing.
Bottom line: The new dot plot is going to look totally different than it would’ve looked absent the SVB meltdown and it’s possible the inflation forecasts will likewise be impacted by the banking tumult.
Terminal rate pricing for the ECB and the BoE was also impacted. The former was pared by 50bps, and the latter by even more. Christine Lagarde will have to acknowledge the risk of contagion from the US banking sector later this week.
This raises the stakes considerably for the incoming data. The Fed will insist the inflation fight continues, but hiking rates another 50-100bps (consistent with what markets and Fed officials were planning on as of last Tuesday) into the teeth of a banking sector crisis is a suicide mission.
If the Fed has any sort of forward looking outlook, they will end QT and pause.
They have barely started QT.
$5T was added to the balance sheet in one year.
They have barely scratched the surface.
So is 2% inflation too hard to achieve, and if so, how is this good for stocks and long bonds?
And here is exactly why the rich always get richer. Because the rich never have to suffer consequences when they make bad investments. With Fed thumbs on the market’s scales it’s impossible for an intelligent investor to ever make any gains. Value investing is dead.
Everyone’s holdings (including rich people) of Silicon Valley Bank stock has gone to $0. Holders of any Silicon Valley Bank bonds are also getting hit and may also end up at $0. Same may be true for Signature Bank. So those rich people are not getting richer from this gov’t action.
+1
+1 to cdameworth, not you
The Fed created the liquidity facility (Bank Term Funding Program (BTFP)) and yields on treasuries fell. Financial conditions eased and inflation (especially in stocks) might be higher as a result. Mortgage rates might fall?? Banks are now protected by BTFP. It would be asinine for the Fed to pause now!! Will this be Jay Powell’s “G. William Miller moment” to pause or will the Fed hike? History wants to know.
Rates are down – quick which bank wants to sell some AFS securities to solve their liquidity issues?
I’m confused though. Weren’t high rates supposed to be good for banks?
I’m taking the other side of this move. I expect the 2-Year to start selling off again in the near future. Does anyone know about an inverse 2-Year ETF? I see plenty of long end inverse US Treasury ETFs but not 2-year/short end. Thanks
Not an inverse but fairly nimble – SHY
I’ve been generally correct in my assumptions about what the Fed would do over the past year thanks to two simple hueristics:
1) The Fed means what they say.
2) The Fed wants to be a source of stability.
The second point has been the real defining characteristic of Fed actions and statements. The greatest illustration of that was when data released during the fedspeak blackout window necessitated raising rates at a faster than anticipated pace. Rather than surprise markets, the Fed communicated the information via a link to Nick T. They didn’t need to leak that. If indeed the Fed had “surprised” markets, it would have likely been celebrated by most pundits. It would have showed seriousness about the inflation fight and a major step towards restoring Fed credibility.
“Restoring Fed credibility” has been a major theme recently, so for the Fed to choose predictability over credibility is instructive. For over a decade they were the supplier of convexity through low rates and large asset purchases. Now that they can no longer supply convexity through those channels, they instead provide it by being as absolutely predictable as possible. In other words, they mean what they say (and then they do it).
Now for the first time, we find points 1 and 2 in conflict. The Fed has said they will prioritize the inflation fight above all else. They also want to be a source of stability. Stability requires a strategic pause in acknowledgement that a years’ worth of tightening has strained elements of the banking sector to the breaking point. The inflation fight suggests the very tightening which, 3 trading days ago, was priced into rates.
It will be interesting to see how Powell and company resolve this dilemma.
I agree that this a real Volcker moment: ideally they’ll raise 25 bps so that the markets (and especially banks) get the message that inflation is still not yet under control. (And loudly explain how the new SaveBanksTools solve liquidity/depositor concerns).
That being said I’m personally gambling there’s at least a month bull run by the markets as speculation “this is the end of rate hikes” runs wild.
So they raise rates until they “break” the venture capitalists and zombie companies, then they bail them out. Then they continue raising rates to crush mainstreet and “ conquer” inflation?
Wouldn’t it be more equitable to let the speculators take the hit, let the zombies go under, tank the stock market, get the damn recession started.
Inflation solved!
The fed saw this coming, been financing these VC regional banks for the last year, we all know who has to pay the price…..main street
https://wallstreetonparade.com/2023/03/silicon-valley-bank-was-a-wall-street-ipo-pipeline-in-drag-as-a-federally-insured-bank-fhlb-of-san-francisco-was-quietly-bailing-it-out/