Central Bank Watch – Systemic Risk and The Federal Reserve

It will be a busy week for central bankers and investors alike. Up front is the risk of contagion in the financial sector from the two bank failures, Silicon Valley Bank and Silvergate Capital Corp. We have the backdrop of a more hawkish Fed Chair in the face of escalating systemic risk. How will this affect Fed policy given the massive treasury positions out there and the risk of uninsured funds? Ahead the ECB and the Bank of Indonesia will decide on the course of monetary policy. In this environment we get US inflation and retail sales data. How much damage is the Federal Reserve willing to do in the guise of controlling inflation?

We had the Biege Book last week concluding inflationary pressures remained widespread, though notably price increases moderated in many Districts. The Bank of Japan made no changes to its policy stance in Governor Kuroda’s final policy meeting. The appointment of Kazuo Ueda was confirmed by Japan’s government.

This past week we saw the Bank of Canada maintain its overnight rate at 4.50% in March 2022, as expected. The move follows the aggressive hikes at the last five meetings. The Reserve Bank of Australia raised interest rates for the tenth consecutive time on Tuesday to the highest level since May 2012. The National Bank of Poland, BCRP (Peru) and Bank Negara (Malysia) all held steady.

Central bank monetary policy decisions and market activity interest rate decisions can have a dominant effect on financial markets, fiscal policy and geopolitics. We keep an eye on key banker developments, what they mean and what is ahead.

Central Bank Weekly Analysis and Outlook – Banker dynamics are complex. There are myriad facets to analyze and contemplate.

To say central bankers, have issues is an understatement. Already grappling with the quickest inflation in decades they now have these decisions to make, forcefully raise borrowing costs to defend currencies and risk hurting growth, spend reserves that took years to build to intervene in foreign exchange markets, or simply stand aside and let the market play out.

Central Bank Highlights This Past Week:

Most of the G10 central banks may complete their rate hike cycles around the middle of the year or earlier, the unwinding of central bank balance sheets may continue longer, depending on the damage done.

This week’s central bank main events included:

  • Fed Chair Powell’s testimony before the Senate Banking Committee. “Although inflation has been moderating in recent months, the process of getting inflation back down to 2 percent has a long way to go and is likely to be bumpy. As I mentioned, the latest economic data have come in stronger than expected, which suggests that the ultimate level of interest rates is likely to be higher than previously anticipated. If the totality of the data were to indicate that faster tightening is warranted, we would be prepared to increase the pace of rate hikes. Restoring price stability will likely require that we maintain a restrictive stance of monetary policy for some time.”
  • European Central Bank policymaker Rehn hinted at a “fairly significant” rate hike in March while ECB policymaker Centeno said that the central bank is targeting headline inflation rate instead of the core rate.
  • European Central Bank policymaker de Cos said that CPI will remain high in the short-term, but he also expects that Spain’s GDP outlook will be revised higher while the CPI forecast will be revised lower
  • Bank of England policymaker Mann expressed a concern over persistent core inflation.
  • Reserve Bank of Australia’s Governor Lowe said that the central bank is getting closer to a point where a pause in rate hikes will be appropriate.
  • European Central Bank policymaker Knot said that the ECB will continue raising rates for “quite some time” after the March meeting while policymaker Visco said that he does not appreciate other members discussing a prolonged rise in rates.
  • Swiss National Bank President Jordan said that monetary policy remains too loose.
  • European Central Bank policymaker Villeroy de Galhau repeated that inflation in France and the eurozone remains too high.
  • The Bank of Japan made no changes to its policy stance in Governor Kuroda’s final policy meeting.
    Meanwhile, the appointment of Kazuo Ueda was confirmed by Japan’s government.

Eyes on the Bond Market

U.S. Treasuries rose sharply Friday surge, which extended the market’s strong bounce that took shape on Thursday. Treasuries surged with growing uncertainty over SVB Financials’ future and a concern that the bank’s share price collapse could be indicative of a bigger issue in the banking system. FDIC announced the seizure of SVB Financials’ assets, making for the second largest bank failure in the history of the United States. Treasury Secretary Yellen said that the banking system remains resilient, but she also acknowledged that “a few” banks are being monitored by the Treasury Department. The 2s10s spread ended the week at -89 bps, widening by a sole basis point since last Friday.

Yield Watch

  • 2-yr: -29 bps to 4.59% (-27 bps for the week)
  • 3-yr: -28 bps to 4.28% (-32 bps for the week)
  • 5-yr: -27 bps to 3.95% (-30 bps for the week)
  • 10-yr: -23 bps to 3.70% (-26 bps for the week)
  • 30-yr: -17 bps to 3.70% (-19 bps for the week)

Highlights – Federal Reserve

  • Federal Reserve Credit declined $27.5bn last week to $8.305 TN.
  • Fed Credit was down $596bn from the June 22nd peak.
  • Over the past 182 weeks, Fed Credit expanded $4.578 TN, or 123%.
  • Fed Credit inflated $5.494 Trillion, or 195%, over the past 539 weeks.
  • Fed holdings for foreign owners of Treasury, Agency Debt increased $7.1bn last week to $3.360 TN.
  • “Custody holdings” were down $72.7bn, or 2.1%, y-o-y.

Rate markets saw Fed rate hike expectations continued to creep higher and is now pricing peak Fed funds at 5.40% for the June 24th FOMC meeting, up 12 bps this week and 56 bps since February 2nd. Expectations for the December meeting policy rate jumped 22 bps this week (up 88bps in three weeks) to 5.28%. Market pricing now has consecutive rate increases at the March, May and June FOMC meetings, with about a 20% probability for a 50-bps hike next month.

Fed 2023 Bank Stress Tests.

Update: This got more interesting with the two bank failures in a week, including a spectacular bank run gutting an institution with assets exceeding $200 billion. Silicon Valley Bank (SVB) was the largest failure since Washington Mutual’s September 2008 collapse. It was also the second largest in U.S. history.

SVB is the dominant financier for Silicon Valley startups. SVB ended 2022 with a $120 billion securities portfolio, the vast majority mortgage securities (MBS and CMOs). SVB’s spectacular collapse will have a major negative impact on its $74 billion loan portfolio.

Silvergate Capital Corp. plans to wind down operations and liquidate its bank after the crypto industry’s meltdown. Silvergate collapsed amid scrutiny from regulators and a criminal investigation by the Justice Department’s fraud unit into dealings with fallen crypto giants FTX and Alameda Research. Silvergate’s woes deepened as the bank sold off assets at a loss and shut its flagship payments network, which it called “the heart” of its group of services for crypto clients.

The Federal Reserve last month released the hypothetical scenarios for its annual bank stress tests. This year, 23 banks will be tested against a severe global recession with heightened stress in both commercial and residential real estate markets, as well as in corporate debt markets. Last year the Fed found all 34 large banks tested remained well above their risk-based minimum capital requirements, and the Fed announced no restrictions relating to dividends and buybacks.

Central Bank Week Ahead:

In the week ahead we have key monetary policy meeting, from

In the week ahead we get three central banks delivering policy decisions.

This Week’s Interest Rate Announcements (Time E.T.)

  • Thursday, March 16, 2023
  • 02:30 BI Interest Rate Decision
  • 08:15 ECB Interest Rate Decision

This Week’s Central Bank Speeches, Meetings (Time E.T.)

Monday, March 13, 2023

  • 12:00 German Buba Balz Speaks
  • 13:05 BoE MPC Member Dhingra Speaks

Tuesday, March 14, 2023

  • 17:20 Federal Reserve Board Governor Michelle Bowman speaks on “The Innovation Imperative: Modernizing the U.S. Banking System” before the Independent Community Bankers Association’s ICBA Live 2023, Text available. No Q&A. No webcast.
  • 18:50 BOJ Monetary Policy Meeting Minutes

Wednesday, March 15, 2023

  • 19:30 RBA Bulletin

Thursday, March 16, 2023

  • 02:30 BI Interest Rate Decision
  • 08:15 ECB Monetary Policy Statement
  • 08:15 ECB Interest Rate Decision
  • 08:45 ECB Press Conference

Friday, March 17, 2023

  • None Seen

Federal Reserve FOMC Schedule 2023

  • January 31-February 1, 2023 (second day: statement released 1400 EST/1900 GMT; news conference expected 1430 EST/1930 GMT)
  • March 21-22 (second day: statement released 1400 EDT/1800 GMT; news conference expected 1430 EDT/1830 GMT)
  • May 2-3 (second day: statement released 1400 EDT/1800 GMT; news conference expected 1430 EDT/1830 GMT)
  • June 13-14 (second day: statement released 1400 EDT/1800 GMT; news conference expected 1430 EDT/1830 GMT)
  • July 25-26 (second day: statement released 1400 EDT/1800 GMT; news conference expected 1430 EDT/1830 GMT)
  • September 19-20 (second day: statement released 1400 EDT/1800 GMT; news conference expected 1430 EDT/1830 GMT)
  • October 31-November 1 (second day: statement released 1400 EDT/1800 GMT; news conference expected 1430 EDT/1830 GMT)
  • December 12-13 (second day: statement released 1400 EST/1900 GMT; news conference expected 1430 EST/1930 GMT)

The Fed with a Strong US Dollar

The strong dollar is likely to negatively affect the US economic outlook and could alter the Federal Reserve terminal interest rate, economists surveyed by Bloomberg said. Just 28% saw the currency strength as unlikely to have any impact.

The survey of 40 economists was conducted Oct. 21-26.

  • 44% said they believed the Fed could fully complete its aggressive rate tightening despite possible stresses.
  • 38% said the policy makers would be forced to cut rates earlier than expected and
  • 18% said the Fed would not be able to raise rates as much as planned.
  • Survey respondents expect rates to peak at 5% early next year and a majority of the economists now expect a US and global recession.

The Fed as expected raised another 50 basis-points last meeting. The median estimate for the terminal rate in 2023 had been raised to 5.10% versus the September projection of 4.60%. The value of the dollar is an important component to lowering inflation. A stronger dollar tends to dampen inflation by reducing the costs of imports and lowering domestic production as it raises export prices.

“Usually the trade deficit would balloon when the dollar appreciated as much as we had seen since last year. But that effect has been curiously absent so far, even as we are already about five quarters into the appreciation process. One possible explanation is that US is increasing its exports in energy products. The fact that this tightening channel of dollar is absent means that the dollar appreciation is less contractionary to the economy than historically.”

Anna Wong (Bloomberg chief US economist)

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