Financial markets on Monday appeared to position themselves for a slower pace of rate hikes in the US, or even a pause, amid talk and expectations that the Federal Reserve may adopt a more cautious monetary policy following the collapse of Silicon Valley Bank.
The European Central Bank this week still is expected to raise interest rates by 50 percent amid global market turmoil caused by the collapse of Silicon Valley Bank, which fell victim due to mismanagement of its interest rate risks.
“We are shifting away from a perception of fiscal dominance to financial dominance in monetary policy, with the market attaching some probability to the fact that central banks can’t hike rates to the degree that is needed to deal with inflation,” said Katharine Neiss, chief European Economist at PGIM Fixed Income.
In Monday’s trading, the bellwether US interest rate - as measured by the yield on 10-year Treasuries - declined as much as some 27 basis points to touch 3.429 percent, its lowest level since the beginning of February. The declining US yield was mirrored in Europe, where the yield on 10-year German government bonds declined 28 basis points to 2.21 percent.
Open arguments among ECB board members
Markets will be watching the ECB for its tone of voice on the future interest rate path. European central bankers have openly argued about this in recent weeks. From Italy, they pointed to small signals that inflation would be past its peak. Central bankers from the Netherlands, Belgium and Austria, among others, are on a different tack and want to tighten more.
“In short, the ECB has reason to stress that interest rates need to rise further and will remain high for quite some time,” Luc Aben, strategist at Van Lanschot Kempen said in a note to clients. “But unlike last time, there may not be an advance announcement on the size of the next interest rate step.”
Goldman no longer sees US rate hike
The Federal Reserve will update its guidance on US rates next week. Goldman Sachs said on Monday that it no longer expects an increase in US rates following the support measures for SVB depositors. Goldman said it sees “considerable uncertainty about the path beyond March.”
In Europe, AXA Group chief economist Gilles Moëc expects the Fed will likely refrain from major rate hikes now that the US central bank has had to deploy heavy measures to prevent possible spillover effects from the collapse of Silicon Valley Bank. “Unless inflation data come in noticeably above expectations this week, 25 basis points should remain the pace,” said Moëc.
Natixis view unchanged
At French asset management firm Natixis, global macro and market strategist Nicolas Malagardis said he expects the ECB will stick to its guns on Thursday and deliver a hike of 50 basis points. “Market’s volatility has increased in recent days, but this has not changed our view on ECB’s hike: +50bp remains our base case.”
Franck Dixmier, global CIO fixed income at AllianzGI, shared that view. He expects investors to look for any indications about the pace of future rate rises. “With persistent underlying inflationary pressures, we expect the central bank to continue to tighten monetary policy,” he said.
“It will be interesting to listen to (ECB President Christine Lagarde’s) indications about the decisions in the upcoming meetings, and the pace of future rate hikes (of 25bp or 50bp),” Dixmier told clients.
The ECB on Thursday also is expected to take questions on the management of interest rate risks by European banks. As bank supervisor, the ECB in recent months, by word of its Supervisory Board chair Andrea Enria, has repeatedly expressed concern about the way European banks manage interest rate risks, encouraging banks to adjust strategies. Mismanagement of interest rate risk was seen as the main cause of the collapse of SVB.
Strategist Jim Reid at Deutsche Bank said in a note to clients that SVB’s crash reflects a traditional boom-bust cycle. “That being… too much stimulus -> very high inflation and an asset bubble -> aggressive central bank hikes -> inverted curves -> tighter lending standards/accidents -> recession,” he said.
“SVB’s woes are a combination of one of the largest hiking cycles in history, one of the most inverted curves in history, one of the biggest bubbles in tech in history bursting, and the runaway growth of private capital. The one missing ingredient not involved here is a U.S. recession,” a Deutsche Bank strategy note said.
New US funding programme
The Fed has implemented a Bank Term Funding Programme (BTFP), which allows banks to access liquidity without having to resort to selling assets when funds are withdrawn. Additionally, the government has guaranteed all deposits with SVB, even those exceeding the standard 250,000 dollar limit of the US deposit guarantee system.
The goal of these measures is to prevent other institutions from being impacted by a potential bank run, which can occur when customers lose confidence in a bank and begin withdrawing their funds.
“This is especially crucial for banks associated with private equity or the crypto world as demonstrated by the recent closure of Signature Bank,”, Aben said. “While these measures may be considered bold, they are necessary to prevent a small issue from escalating into a much larger problem.”