(Bloomberg) — Less than a week after Federal Reserve Chair Jerome Powell opened the door to a re-acceleration in the pace of interest-rate hikes, traders slammed it shut again amid the sudden eruption of financial strains at US regional banks.
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Goldman Sachs Group Inc. economists said they no longer expect the Fed to deliver a rate increase next week, even after US authorities moved to contain a crisis spurred by the exodus of depositors from Silicon Valley Bank and Signature Bank.
Treasury two-year yields dropped 18 basis points to 4.34%, heading for their steepest three-day decline since October 1987, when the Black Monday equities rout stunned markets. Just as that shock interrupted a tightening cycle, traders are now rapidly shifting back to betting on Fed rate cuts for the second half of this year.
The risk of a banking crisis underscores the tension between Fed efforts to cool the economy and tame inflation with burgeoning concerns that 4.5 percentage points of rate hikes in the space of a year will spark a recession and a rout in riskier assets.
Fed officials are entering a quiet period before the March 21-22 meeting. Economists as of last week were overwhelmingly expecting a quarter-point increase at the meeting, with six forecasting a half-point move.
Regulators Respond
US regulators were spurred into action Sunday to contain the problem. The Fed set up a new emergency facility to let banks pledge a range of high-quality assets for cash over a term of one year. Regulators also pledged to fully protect even uninsured depositors at SVB and relaxed terms for lending through the Fed’s discount window.
Those measures should provide “substantial liquidity to banks facing deposit outflows and to improve confidence among depositors,” Goldman’s Jan Hatzius wrote in a note. Still, he pulled his previous call for a quarter percentage point increase next week and said there’s “considerable uncertainty” about the path beyond then.
Yields on two-year Treasury notes had surged above 5% last Wednesday, to the highest level since 2007, in the wake of Powell’s signaling that a 50 basis-point rate hike was on the table if upcoming economic reports kept coming in hot ahead of this month’s meeting.
The Fed is now seen as likely to raise rates a quarter point next week. The Fed funds rate may peak at about 5.1% in six months from now, the OIS curve shows, down from a terminal rate of 5.74% priced on Wednesday.
Eurodollar markets moved to bet on two Fed rate cuts for the second half of the year.
Swaps traders also reduced their projections for six-month changes in central bank rates across eight major developed-market economies, with Canada and Norway seen holding policy over that time frame. Australia’s central bank is now seen as better than a 75% chance to hold rates next month, OIS contracts show.
Flare Up
“We continue to look for a 25 basis-point hike at next week’s meeting,” Michael Feroli, chief US economist at JPMorgan Chase & Co., said in a note Sunday. “Even before the problems flared up in the banking sector, we thought a 50 basis-point move would be ill-advised, and we still think that is the case.”
Moving by a lesser magnitude — or even pausing the tightening campaign — would give Powell and his colleagues more time to assess whether there are further problems to emerge in the banking system. A senior US Treasury official told reporters on a call Sunday that there are some institutions that look like they have some similarities to SVB and perhaps to Signature.
“It may take some time before the full ramifications of SVB’s collapse are apparent,” Tom Kenny and Arindam Chakraborty, economists at Australia & New Zealand Banking Group, wrote in a note Monday. “Front of mind for markets is the risk of contagion, deteriorating risk sentiment and potentially a broader financial crisis.”
Meantime, economic data are still pending. On Tuesday, Fed policymakers will get the latest reading on inflation, with the consumer price index for February due. Economists see the CPI rising 0.4% from the previous month, down slightly from a 0.5% gain in January.
(Updates with background on efforts to contain inflation)
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Source: finance.yahoo.com