But the Fed has responded to the financial risks very strongly, further suggesting that the room to fight against inflation has been maintained. Further, steps to add liquidity to prevent a financial crisis could mean more risks of inflation. Some may also argue that with the backstop in place, the Fed can continue to raise interest rates without harming held-to-maturity assets, since they can still be traded in at par if banks need liquidity. This enables the Fed to go higher for longer. Could we start to see more tightening expectations being priced in again if the fallout from SVB is contained but US CPI comes in hot once again on Tuesday?
Longer term, this may impact the US tech startup productivity
The SVB crisis has highlighted the pains of the US tech sector, where demands for withdrawals possibly ramped up as liquidity pressures worsened. While the Fed has been nimble on addressing financial stability risks, fear waves are rippling through the entrepreneurial sector in the US especially in the tech space, and that may potentially leave some long-lasting scars on the productivity of the tech sector. VC funding could continue to weaken as interest rates remain high, impacting the innovation in the tech sector.
US equity futures and Asian equities have responded positively to the news of a backstop funding, but Treasury yields continued to slide and the US dollar weakness also extended further as calls for Fed’s tightening path continued to ease. Risk rally could extend into the US session after a sharp drop in equities last week.
Friday’s US jobs report was mixed but the headline continued to hint at labor market tightness. Tuesday’s CPI release will be the next big test of the Fed path from here, and if it is evident that inflation risks remain prominent, while the Fed can convince the markets that financial risks will be responded to, then yields could reverse back higher once again and USD could strengthen. Equities will likely continue to be under pressure, and the pressure on smaller businesses (best represented by RUSSELL 3000 index) or the tech innovation could mean these parts of the market could continue to shed their froth. This continues to emphasise that flight to quality will be key for portfolios as the Fed tightening cycle continues.
However, even if the Fed goes ahead with a 25bps rate hike next week, there will be considerable uncertainty on the outlook if the market continues to believe that the Fed won’t hike rates higher and keep them there for longer. How the Fed addresses these market concerns will be key to watch from here.