Everyone is now speculating as to whether or not the Fed will raise rates by 25 bps later this month or not at all. Most observers currently believe 50 bps is off the table following the collapse of Silicon Valley Bank (NASDAQ:SIVB). The Fed’s aggressive rate increases helped to push banks over the edge as long-duration assets held by banks sank in value, shooting a hole in their balance sheets. The US government announced yesterday it would backstop all deposits, not just $250,000 or less, at any crumbling bank in an attempt to reassure a traumatized market. This aggressive move has helped, but questions linger as to what will happen next.
CI received a comment from Eric Vanraes, Portfolio Manager of the Strategic Bond Opportunities Fund at Eric Sturdza Investments, regarding his expectations for the Fed’s next move. Vanraes said that typically the Fed would be focusing on price stability and full employment, but now they have a bigger concern.
Vanraes said that for over a month, investors have wondered when the next catastrophe would hit. Last week was it.
“The adage ‘you can’t make an omelet without breaking eggs,’ could be translated into “the Fed can’t hike rates from 0% to 5% without impacting some financial players.” The SVB story now reminds us of two precedents: Washington Mutual, which collapsed in 2008 for the same reasons, and the 1987 US Savings and Loans crisis and its domino effect,” Vanraes said, adding that the Fed now finds itself in a “terrible bind.”
“So what can we expect from the next FOMC meeting? It is highly probable that there will be no 50 basis point increase in Fed funds on 22 March. The worst-case scenario would be a rate cut, but we think it is far too early to contemplate that,” predicted Vanraes. “We do not yet know the full implications of the SVB scandal – and it is a scandal – nor whether we will experience a systemic crisis or a few quickly and cheaply contained disasters.”
Vanraes expects that longer term, the uncertainty of the US banking system should “kill off” the Fed’s policy of larger rate hikes. He pointed to 1992 when the Swedish Riksbank raised rates to break a speculative devaluation of the Swedish krona. While effective in defending the krona, it came at a cost of bankrupting its banking system.
“For now, markets are not anticipating a Lehman Brothers style panic, and based on existing information, that is a reasonable response. If we were in a Lehman-style environment, the Fed would have already cut rates. Instead, the Fed knows that any further rate hike could trigger further bankruptcies in banks, hedge funds, pension funds, and the real estate market,” added Vanraes. “Last week, it still looked plausible that the SVB case would prove a storm in a teacup. It looks now more likely that March and April could provide a turning point in bond markets. Let’s hope that central banks will prove wiser than SVB’s bankers.”