As the US prepared to grapple with a fresh read on inflation, the market discussion centered on whether the Fed should, shouldn’t, would or wouldn’t hike rates next week given the turmoil in the banking sector.
In the wake of the emergency actions taken to stabilize the situation, Goldman said the Committee will likely pause in March and Barclays reversed a call for a 50bps move. Following the jobs report, Barclays said a re-escalation to a half-point cadence from Jerome Powell was the most likely scenario. Now, the bank thinks 50bps is “off the table.”
“The decision point will be between a 25bps hike or a pause [and] although we cannot rule out the first scenario, we believe that the most likely outcome will be a pause,” Barclays wrote, citing “financial market turbulence and signs of a sudden intensification of risk aversion.” Meanwhile, Nomura suggested the Fed may consider a cut and could halt QT.
Financial conditions, on Bloomberg’s index, moved quickly into restrictive territory amid the fallout from the bank failures.
Do note: Even if yields reverse sharply from here, the bull steepening that played out over the past three sessions (as two-year yields plunged the most since 1987) was very ominous.
If the better recession indicator is the re-steepening (not the inversion), then consider a recession a done deal. The 2s10s retraced half of what was a post-Volcker, triple-digit inversion extreme in the space of just 72 market hours.
Of course, these are odd circumstances. I readily acknowledge that in light of recent events, the yield curve does appear to have once again “ferreted out” trouble months in advance, but the chart shows an almost vertical, ~60bps re-steepening in three sessions. That’s probably too far, too fast. Sure, some of it’s signal: The Fed is far less likely to push the envelope, and stress in the banking sector does portend tightener lending standards and thereby less credit creation to the real economy, which in turn should bias policy dovish going forward. But some of it’s “noise” too: Stop-outs and squeezes at the front-end.
In any case, the optics for the Fed will be challenging either way. Irrespective of what Tuesday’s CPI showed, inflation isn’t anywhere close to “contained,” but notwithstanding any dip-buying over the rest of the week, the price action in regional banks+ on Monday suggested the SVB collapse wasn’t contained either.
Sure, there’s something undeniably ridiculous about pausing a hiking cycle with inflation still ~triple target, but there’s something even more ridiculous about hiking rates 10 days after you availed yourself of an emergency, “systemic risk” exception because you were worried about a rash of bank runs.
In a “Q&A”-style note, Goldman’s David Mericle and Jan Hatzius did a decent job of reconciling and making sense of all this. I should emphasize that nothing is clear-cut right now. That is: Everyone has a strong opinion about the events that transpired over the past few days, but there’s nothing like unanimity. The world isn’t black and white. It’s not as simple as “I’m against ‘bailouts.'” Or, on the other side, “If an arm’s-length VC bailout is what’s necessary to keep America’s community and regional banks from collapsing, that’s a small price to pay.” This is a many-sided debate, and there aren’t any straightforward answers, let alone any answers that are unequivocally “right” or “wrong.”
With that in mind, here’s what Goldman had to say about some frequently asked questions:
Q: Are whatever risks remain really significant at a macroeconomic level?
A: Possibly, though it depends on how much pressure smaller banks remain under. Even if the BTFP reduces the risk of a fast-paced run and bank failure like that seen last week, continued pressure on small bank deposit bases could persist. If so, even if only a few small banks face the strongest pressure, other small banks might also be conservative about lending in the near-term in order to preserve liquidity in case they need to meet depositor demands. The impact on economic activity could be meaningful because banks with less than $250 billion in assets account for about half of US commercial and industrial lending and the majority of residential and especially commercial real estate lending. We think the economic risk is significant enough to add to the sense that pausing in March is the prudent choice.
Q: Doesn’t high inflation call for further interest rate hikes?
A: Probably. Our base case is therefore a resumption of gradual 25bps interest rate hikes in May and an eventual peak funds rate of 5.25-5.5%. But financial stability is an immediate concern and policymakers need to safeguard it at every point in time, while inflation is a much slower-moving problem. The FOMC’s economic projections indicate that it expects to get back to 2% inflation only gradually over the next couple of years, and the link between a single 25bps hike and progress in bringing down inflation is weak. Moreover, there is no sign in either the TIPS market or household surveys that longer term inflation expectations — the holy grail of central banking — are unanchored.
Q: Won’t financial conditions ease if the Fed pauses?
A: It is possible that market-based measures of financial conditions could ease, though this might be offset by a tightening in bank lending standards. Another consideration is that a repricing of rate expectations directly helps to address banks’ losses due to duration risk. As a result, the lower expected rate path might have a stronger than usual direct link to financial stability and might therefore be more acceptable than it would be if inflation were the only concern, at least until financial stability risks diminish.
Q: Didn’t low interest rates contribute to this problem? How can they be a solution?
A: While a long period of low interest rates might have contributed to inadequate preparation for the risk of a sharp rise in interest rates, we think Fed officials will be much more focused at the moment on the immediate problem of preventing further near-term financial instability.
I’ve been told many times to fear the steepening, so I’ll use the nascent rally to position accordingly, this time will not be different.
I get that things are not black and white. But consider this, if the shoe was on the other foot, what would the Vulture Capitalists have done in this scenario? Considering the damage they have inflicted on health care, elder care, farming, and housing all to maximize profit. It seems to me that it is a “moral hazard” to use government funds to keep them in business.
What about the people at the startups who’d be out of a job? “Oh well, you should’ve asked your CEO if she had properly assessed the duration risk on the balance sheet of your company’s bank”?
I mean, if something terrible happens to you tomorrow, and it’s the fault of your employer and your employer’s bank, and the government steps in to save you, do you want to go online and hear everyone talk about what a free-loader you are? Are you going to turn down the assistance and then proudly take to Twitter to declare yourself a virtuous individual who’d never take a “hand out”?
No, you wouldn’t do either of those things, and we all need to stop pretending like we would.
Do note: That doesn’t mean you’re “wrong” in your assessment. Nor does it mean anyone is “wrong” to criticize this entire fiasco as a “bailout.”
What I’m saying is: Keep it real. Seriously. All day long, every day, Americans are online deriding other Americans based on the idea (implicit) that if they were in dire straits, they’d behave in this or that way, when in reality almost nobody would. It’s just posturing for the sake of it.
I’m not criticizing the employee here. I’m criticizing the people who typically cause unemployment in industries they infiltrate are being taken care of by the government. We have no guardrails that prevent VC’s from taking over a hospital and gutting it of it’s staff and forcing it to turn away patients who need care because they don’t have any or the right kind of insurance. And then when those same VC’s make bad investments the government jumps at the opportunity to take care of them? So we can watch them infiltrate another industry (daycare centers?) and force under-supported Americans to either pay way more than they should or to find another option.
Let’s be clear, when a person goes to the hospital to get treatment for an active pandemic, the Fed doesn’t come in and bail them out of their 30k hospital bill. They go bankrupt.
When a VC invests money at a questionably managed bank that goes under, they get a bailout 2 days later.
The distinction is disgusting.
I think you’re conflating a whole bunch of different stuff here in an effort to make yourself as mad as possible. For example, private equity isn’t the same thing as venture capital. And I could go on, but I’m not going to, because it’s not constructive.
CD may be getting the player names wrong, but his observations about hedge fund/PE “investments” in the hospital space should concern everyone. Exhibit One has been the takeover of emergency room staffing leading to egregious “out of network” bills if you bring a child with a sports injury in for treatment. More recently a little light has been shined on the firms that bring in travel nurses from the Philippines and such. (They are often treated as indentured servants.)
That said, blame for these is shared by hospital administrators who delight in outsourcing everything to juice up returns.
Well getting the player names right is pretty important, no? If I say “Derek broke into my house and stole my TV” when in fact I meant Darrell, that’s a pretty big deal when the police come knocking on your door, isn’t it?
Good point there, Dear Leader. Politicians are not always careful with their words.
But the private players face no real threat since the SVB failure was due to over-attention to woke ESG issues.
PS – I always knew that Darrell was a criminal!
But isn’t the idea of raising interest rates to fight inflation to put people out of work to increase unemployment? Instead of putting people who work in real estate, construction, auto industry out of work, why not put it on the VC and startups?
Maybe they’ll have to sell their foosball tables and massage chairs.
I’m not unsympathetic to people who lose their job, but seems like this would get the unemployment numbers up and fight inflation just as well as choking the economy from the other end.
Its disappointing to read a comment here, where most are more sophisticated than anything I can usually offer, that seemingly lumps together practitioners of venture capital, private equity and vulture capital – 3 very different investment styles. Per Investopedia, “A vulture capitalist is an investor who seeks to extract value from companies in decline. The goal is to swoop in when sentiment is low–and the company is trading at a rock bottom price–and take whatever action is necessary to engineer a quick turnaround and sell it on for a profit.”
The broad brush characterizations may be valid for actual vulture capitalists, and many in the PE world – but the venture capitalists and their progeny caught up in the SVB disaster are largely of a different stripe (perhaps deserving of criticism, but not for the sort of damage suggested above.
My two cents as someone in tech (although the company I work for didn’t bank with SVB nor is it funded by VC/PE): the shakeout in tech is already happening and many VCs will lose a lot of money as companies go under. However, a bank run is not an orderly way to manage the situation and letting SVB go under without backstopping depositors would have made everyone far worse off.
As has been alluded to in these pages many times, the reality is that even in downturns where capital takes a huge hit, the wealthy will still have millions (or billions) in assets and won’t see a significant change in quality of living. Advocating for bankruptcies and job losses in order to punish the investor class is the ultimate cut off your nose to spite your face move.
If we ever got our political act together, we’d focus more on progressive taxation and UBI, but those are pipe dreams for now. In the meantime, I’d just second H’s advice about keeping it real and constructive.
Oh, and put publicly funded healthcare and childcare on my wishlist as well 🙂
“…inflation isn’t anywhere close to ‘contained’…”
Say what you will about the rest of it, that’s a true statement.
Right. And it’s like the fact that the US just experienced the second and third largest bank failures is just kind of a meh…thing. Inflation is not coming down until enough regular folks are scared. Bank runs used to be scary, but it seems it’s baked into our collective conscience the Fed, or Congress, or the Treasury will make all scary things go away. Let’s face it, most regular folks don’t really know much about how things work, or don’t work. And losing a job hasn’t been scary for quite a while come to think of it. Too much money in the system, for too long has helped created this un-reality. No other actor than the Fed can really make a difference at this point. I think their work is far from done.