Forget politics, these days a week is a long time in monetary policy. From hard landing to soft landing, and no landing, it now appears as the economy is on the brink of a nosedive.
On Friday morning bank stocks and the bond market were screaming at Fed Chair Jerome Powell that the economy was at risk of blowing up due to a Lehman style ‘credit event’ if he didn’t stop increasing interest rates.
It was only on Tuesday that the Chair of the Federal Reserve was remaining steadfast in his hawkishness towards future rate increases “the ultimate level of interest rates is likely to be higher than previously anticipated,” as data suggested that inflation was becoming embedded in the service industry.
By the end of that day Fed Swaps had priced in a 75% chance of a another jumbo 50-bps increase at the next meeting in March.
Today, only two days after Powell’s testimony, the Fed Swaps market has done a complete 180, repricing in a 50% chance of a 25-bps hike as fears of a bank liquidity crisis spread across market.
On Thursday, US and global bank stocks had wiped out over $100 billion in value after Silicon Valley Bank announced plans to raise capital by selling parts of its bond portfolio, the stock closing down 60% and falling a further 20% in aftermarket trading. Later that day TechCrunch reported that venture capital firms were advising companies to pull money from the faltering bank and so began the age old bank run.
Today, news broke Silicon Valley Bank’s attempts to raise capital via the selling of its US treasuries had failed and it was enlisting Goldman Sach’s to begin the process of selling the bank.
Also today, the US treasury department said they were monitoring the Silicon Valley bank crash “very carefully” and that regulators would be visiting the bank to assess its finances. Some hinting that a return to quantitative easing might be on the cards to avoid a full-blown bank liquidity crisis starting.
The collapse of Silver gate ($SI) and ($SIVB) was a wakeup call to investors who realised that the Fed’s aggressive rate rises have exposed a massive underlying liquidity risk banks, as the declining value of long-term US treasury bonds held as security against deposits threatens to blow a massive hole in balance sheets.
While banks have been benefiting from higher interest rates from mortgage holders, what many didn’t realise was that higher interest rates were also eroding the values of long-term US treasuries that many banks hold, exposing them to massive unrealised losses (because of the inverse relationship between bond yields and bond prices, rising yields cause existing fixed-rate recruiters to fall in value).
Today’s much anticipated jobs report showed an unexpected increase in the unemployment rate, from 3.4% to 3.6% for the month of February, while wages increased, but less than expected, showing some signs that the economy is beginning to cool.
Powell is now in a tough spot. Does he attempt to get ahead of the so called ‘sticky inflation’ and return to jumbo 50 bps hikes and in the process likely send many smaller regional banks into liquidation, or does he finally blink, and raise the target inflation from the absurdly low 2% percent target.
Next week’s CPI data will be the clincher.
At the time of writing Fed Swaps were fully pricing in a 25-basis point rate cut by the end of the year.
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