Jerome Powell and the Fed are staring warily at a prospective “damned if they do, damned if they don’t” scenario.

Easing policy now to short circuit stress in the banking sector risks seeing inflation re-accelerate later — a scenario that would demand the resumption of rate hikes.

Ongoing tightening now aimed at “finishing the job” on inflation risks exacerbating stress in the banking sector — a scenario that could lead to a recession later, which would demand rate cuts.

“In the new context of potential fragility of the financial system, it appears that whatever the Fed does (to rates) in the near-term, they will likely have to atone for later,” Deutsche Bank’s Aleksandar Kocic wrote, in a new note. “The more they push in one direction, the bigger the reaction is likely to be in the opposite direction.”

Over the course of just 10 days in March, the future rates distribution bifurcated. Kocic offered the stylized illustration below.

What was a “well-defined pre-March rates range” is now two tails, Aleks said.

On the eve of SVB’s failure, consensus had coalesced around a rates path with a mid-5% handle. Then, the swiftest bank run in American history changed everything.

“What used to correspond to a low-rates risk scenario of a hard landing in the long run, materialized practically overnight as an equally likely possibility on top of the central case,” Kocic went on, in the same note, co-authored by Brian Lu.

They described America’s new banking crisis as manifesting in “strange attractor dynamics related to the emergence of the two centers for the future rates range.”

As noted here on several occasions of late, there’s no modern historical precedent for the erratic behavior at the front-end of the curve and really, the same could be said for STIRs. The figure underscores the point.

Kocic, a veteran of Lehman (and CERN, by the way), commented briefly on recent Minsky moment banter, and also on comparisons to his long, lost alma mater (which he left long before the GFC).

On the Minsky moment meme:

Although some aspects of the front-end repricing and high levels of volatility could prove as temporary, there is a new dimension of uncertainty that the very speed of these developments has revealed, which extends beyond the near-term horizon. This is not exactly a Minsky moment — volatility was high to begin with — but the market was momentarily caught off guard in a state of anxious complacency, when the intensity of the event revealed potential lines of fracture of a consensus that dominated for the most part of the current cycle.

On 2008 comparisons:

To be clear, despite stratospheric levels of rates volatility (predominantly short tenor gamma), this is not a financial crisis of the same depth and scope as the 2008 GFC. After all, in the present case, uncertainty is localized at the front-end of the curve and primarily concerns the future short-rates path and the Fed reaction function. In the past crises, rates and equity vol used to exhibit synchronized spikes, the current episode is clearly a pure rates story. This, to some extent, is a consequence of risk distribution and positioning, as well as the conflicting view of risk assets that remains split between the benefits of economic well-being and the comfort of low rates.

Summarizing what’s unfolded over the past several weeks, Kocic said that at least as it relates to US rates, “March 2023 will be remembered as an accumulation of unprecedented outliers.”