Head of FX Strategy
Summary: The US authorities have stepped with liquidity measures and also announced a new lending program for banks to prevent the risks of a contagion from the collapse of Silicon Valley Bank (SVB) on Friday. Fed pause bets for March are increasing, but the authorities’ response on containing the financial risks suggests that the room to fight against inflation has been maintained. Risks to inflation also tilt further to the upside with the added liquidity measures, and the longer-run impact on US tech sector innovation will remain key to consider in portfolios.
As risks of a contagion from the US bank SVB’s collapse rose last week, authorities have stepped in to contain the fallout and prevent a broader impact on the financial sector. New liquidity measures from the Federal Reserve and the announcement that both SVB and Signature's depositors will be made whole have shielded the banking industry from contagion risks.
The Fed also announced a new lending program called the Bank Term Funding Program (BTFP) which allows any insured depository institution to borrow from the Fed for up to a year using banks' investment securities as collateral. The banks can borrow funds equal to the par value of the collateral pledged, even if the market value of the collateral has been eroded due to high interest rates. This will allow banks to meet withdrawal demands, without having to sell their bonds at a loss as was the case with SVB last week.
So the authorities have not just responded to the idiosyncratic risks posed by SVB, but the breadth of measures from the US regulators suggest they were wary of some systemic risks. Whether those risks have been pre-empted will be key to watch, but near-term relief is likely. The announcement of BTFP will put the depositor concerns at ease about their exposure to smaller regional banks, and clearly puts a floor on any panic brewing in the system for now.
US President Joe Biden will be speaking on Monday morning US time on the SVB situation, and his administration will be briefing Congress. Focus will be on any measure being announced to strengthen oversight and tighten regulation to avoid further banking sector stress as the Fed continues its inflation fight.
The risks of a financial crisis have further complicated the monetary policy response function in the US. Markets went from pricing in a 25bps rate hike for the March meeting to 50bps after Powell’s testimony last week back to 25bps after risks of a contagion in financial sector arose. Terminal rate pricing has gone down from 5.7% last week to 5.0% now. Some banks are also calling for the Fed to pause in March to re-assess the impacts of their policy tightening.
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?
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.
2024: The wasted year
Markets are driven by election optimism, overshadowing growing debt and liquidity concerns. The 2024 elections loom large, but economic fundamentals and debt issues warrant cautious investment.
As US economic slowdown hints at a shift away from exceptionalism, USD faces downside with looming Fed cuts. AUD and NZD set to outperform as their rate cuts lag. JPY gains on carry unwind bets and BOJ pivot.
Amid AI and obesity drug excitement, equities see varied prospects: neutral on overvalued US stocks, negative on Japan due to JPY risks, positive on Europe. European defence stocks gain appeal.
With the economic slowdown, quality assets will gain favour, especially sovereign bonds up to 5 years. Central banks' potential rate cuts in Q2 suggest extending duration, despite policy and inflation concerns.
Commodities poised for rebound. The "Year of the Metal" boosts gold and silver, copper awaits rate cuts. Grains may recover, natural gas stabilises. Gold targets $2,300-$2,500/oz, copper's breakout could signal growth.
Markets are driven by election optimism, overshadowing growing debt and liquidity concerns. The 2024 elections loom large, but economic fundamentals and debt issues warrant cautious investment.
As US economic slowdown hints at a shift away from exceptionalism, USD faces downside with looming Fed cuts. AUD and NZD set to outperform as their rate cuts lag. JPY gains on carry unwind bets and BOJ pivot.
Amid AI and obesity drug excitement, equities see varied prospects: neutral on overvalued US stocks, negative on Japan due to JPY risks, positive on Europe. European defence stocks gain appeal.
With the economic slowdown, quality assets will gain favour, especially sovereign bonds up to 5 years. Central banks' potential rate cuts in Q2 suggest extending duration, despite policy and inflation concerns.
Commodities poised for rebound. The "Year of the Metal" boosts gold and silver, copper awaits rate cuts. Grains may recover, natural gas stabilises. Gold targets $2,300-$2,500/oz, copper's breakout could signal growth.
Disclaimer
The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website. This content is not intended to and does not change or expand on the execution-only service. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.
Please read our disclaimers:
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
- Full disclaimer (https://www.home.saxo/en-gb/legal/disclaimer/saxo-disclaimer)
