Market Briefing: Contagion
A broad selloff in the US banking sector has wiped out billions of dollars in market value and is lowering expectations for rate hikes from the Federal Reserve. The rout began when a rate-related decline in the value of bond holdings, paired with a related drop in technology-sector deposits, forced SVB Financial Group—parent of Silicon Valley Bank—to raise capital through a share sale and sell roughly $21 billion in securities at a loss. Its shares are down more than 79 percent from yesterday’s open, and the financial sector is receiving a pummelling across the board.
Market-implied expectations for the Fed Funds rate in December have fallen precipitously from Wednesday’s peak, dropping from 5.56 percent to 5.20 percent - essentially wiping out a rate hike as investors bet the central bank will be forced to move to a more accommodative footing against a turbulent financial sector backdrop.
But markets may be suffering post-traumatic stress syndrome after a superficially-similar sequence of events nearly took the global financial system down in 2008 - we suspect the issues are far less systemic this time. Silicon Valley Bank is the 18th largest bank by assets in the US, but regulatory changes have likely ringfenced its portfolio more effectively than Lehman Brothers or others ahead of the global financial crisis. Many other institutions have large, illiquid, and loss-making bond portfolios that could make them vulnerable to fire sales in the future, but few have the sort of sector-specific funding issues that are playing a role in SVB’s current troubles.
We suspect fundamentals will soon reassert themselves, with rate expectations rising as the perceived need for a bailout from the Federal Reserve recedes. That said, the episode does remind us of the dynamic that has played out in virtually every rate increase cycle since the seventies: the Fed typically tightens until something breaks, and then tightens some more. Some things never change.
The Bank of Japan‘s Haruhiko Kuroda left benchmark interest rates and ten-year yield targets unchanged in his final meeting as governor, triggering a drop in the yen as bets on a policy adjustment were unwound. In comments after the meeting, Kuroda sought to defend his record in helping to lift inflation, but also acknowledged the imported nature of current price increases, suggesting that gains wouldn’t last. In deliberations concluded shortly after the meeting, the government formally confirmed his successor, Kazuo Ueda, who appears broadly committed to staying the course for now.
The British economy expanded more than expected in January, with a recovery in services spending helping solidify bets on a quarter-point hike at the Bank of England’s meeting in a few weeks. Gross domestic product rose 0.3 percent in January, rebounding from a contraction the previous month, according to the Office for National Statistics. This was higher than the 0.1 percent consensus forecast, and lifted the pound against most of its major counterparts (although gains were limited as global yields subsided). Chancellor Jeremy Hunt’s first budget will land next week, helping to clarify the government’s fiscal plans and set near-term growth expectations.
Consensus estimates suggest that the US will report another 225,000 people were added to non-farm payrolls in February, but conviction is generally lacking - forecasts are widely dispersed, and some mean reversion is expected after January’s unusually-strong 517,000-position gain. Another strong report, particularly if paired with above-trend hourly earnings growth, could lift Federal Reserve rate expectations - but might also force markets to consider slowdown risks that would be associated with an overly-tight policy stance.
Canada is seen generating another 10,000 jobs in February after a blockbuster 150,000-position jump in the prior month, and the unemployment rate is expected to inch up to still remarkably low 5.1 percent. Given that domestic developments are likely to be overshadowed by events south of the border, we suspect it will be difficult to disentangle any observable currency impact from the non-farm payrolls report, but it’s also likely that the Bank of Canada will stay in wait-and-see mode for a few months yet - essentially nullifying any reaction in rates markets. In a speech yesterday, Deputy Governor Carolyn Rogers noted that economic conditions continued to evolve broadly in line with the Bank’s January forecast, and said “We'll still need more evidence to fully assess whether monetary policy is restrictive enough to return inflation to 2 percent”.
KARL SCHAMOTTA, CHIEF MARKET STRATEGIST
USD Non-Farm Payrolls, February
CAD Employment, February
USD Baker Hughes Weekly Rig Count