Pro Perspectives 3/13/23

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March 13, 2023
 
As we've discussed often in my daily notes, in the post-2008 world, we know, with no uncertainty, that the Fed will do "whatever it takes" to maintain financial stability, and to manufacture their desired outcome. 
 
They (and other major central banks) crossed the line in response to the Global Financial Crisis, over the past fifteen years.  There is no going back.  It is now standard operating procedure to fix and manipulate.
 
Among the "fix and manipulate" strategies, is quantitative easing.  And for that (QE), we have no historical reference point of a successful exit.
 
The attempted exits have only led to more control and more intervention by central banks over markets – to plug new leaks in the global economic system. 
On that note, we talked about the blowup/ bank run of Silicon Valley Bank (SVB) on Friday (here).
 
Confidence in the banking system eroded over the weekend, and, sure enough, the Fed stepped in last night, promising to provide liquidity to depository institutions to backstop deposits.
 
Will they have to do more?  Maybe.  Will they do more, if needed? Yes.  "Whatever it takes."
 
So, we've hit the pain threshold for rates in the U.S. economy.  Something (big) has broken:  confidence in the banking system.
 
And the Fed has responded.     
 
Remember, we've seen similar fractures play out in other major economies.  And we've seen the response:  more intervention. 
 
In Europe, a sovereign debt crisis was building back in June, after the ECB announced they would end QE and start hiking interest rates. 
 
But yields had already spiked on the fragile Italian and Spanish sovereign debt, driven by rising U.S. yields. 
 
That was enough to make the ECB balk.  With Italian and Spanish solvency in question, they responded with an emergency meeting, and a new plan (same as the old) to buy bonds (more QE) of the weaker euro zone constituent countries, to defend against what they called "fragmentation" (i.e. an implosion of the euro zone, and of the common currency).  
 
Then in September, the Bank of England was forced to step in, after a doubling of the government bond yields in a little more than a month. 
 
UK pension funds were getting margin calls, where they were forced to sell UK government bonds.  When they sold bonds, yields went higher, which forced more margin calls, which required them to sell more bonds (and a self-reinforcing global sovereign debt spiral was underway).
 
The Bank of England responded, buying bonds (more QE), and reversing the rising tide of interest rates.
 
In both cases (ECB and BOE intervention), with the central banks absorbing stress in the system, yields resolved lower/stocks higher. 
 
This U.S. bank run/confidence crisis and the Fed's response, too, has reversed the tide of market interest rates.  Yields have collapsed.
 
This event should be a clear message to the Fed that they've done too much.   
 
On that note, the Fed Funds futures market has swung from pricing in a chance of 125 basis points of further hikes by June, to pricing in the chance of a rate cut.