Pro Perspectives 3/14/23

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March 14, 2023
Inflation data this morning was fairly uneventful, given the Fed is now more focused on the stability of the financial system.
The Fed meets on rates next Tuesday and Wednesday. 
With some relative calm in the financial sector today, along with an anticipated bounce back in inflation in the February data, the market is now pricing in about an 80% chance that they will go forward with a quarter point hike next week.
The much more important development, is that the interest rate market has now priced out about a 125 basis points of hikes by the end of the year, and has now priced in (at least one) rate cut.
Does this rate outlook imply more cockroaches will be discovered and/or the economy will go into contraction?  Or does this just signal the Fed has reached its limit on what the system can tolerate in this tightening cycle?
Maybe the better question is, did Silicon Valley Bank reveal a systemic problem in banks?  No.  

SVB was a unique bank.  It banked venture capital firms.  And it banked their portfolio companies.  It was a home-grown tool to enable Venture Capital firms to lever their investor capital. 
Most importantly, it had the highest percentage of uninsured deposits (at 97%).  
With that, it made SVB depositors most vulnerable to a bank failure
And the failure became self-fulfilling, by the depositors, via a bank run.  And that was driven by some noisy Venture Capitalists drawing attention to the mismatch of the duration of the bank's assets and the duration of its liabilities (which all banks have, to varying degrees). 
In that respect, what it may have most revealed, is the threat that social media represents as a tool to promote mob behavior.  In this case, depositor fear.
In short, the SVB had depositor capital tied up in longer-term maturity U.S. Treasuries and mortgage backed securities.  The only way it becomes a problem, is if they are forced to sell those securities (prior to maturity) at a loss to fulfill depositor requests for a return of their money (a run on the bank).  It happened.
Did it reveal pain in the system, driven by the Fed's rate hikes and quantitative easing?  Yes. 
But as we've discussed, there should have been no uncertainty about how the Fed would react to crisis. 
Intervention.  And they intervened quickly. 
This response by the Fed didn't create moral hazard.  The moral hazard took place long ago.  This is the product of moral hazard. QE begets more QE. 
The degree of intervention taken place over the past fifteen years, both by the central bank and the government makes comparisons to almost any historical crises almost moot, at this point.  They've proven to be able to manufacture their desired outcome.  
What's the ultimate cost?   The currency is the natural balancing mechanism.  Bad behavior should be penalized with capital flight, higher sovereign borrowing costs and a devaluation of the currency.
But it doesn't happen when everyone else is in the same boat.  No penalties.  And that has been the case, since the Great Financial Crisis.  Sovereign debt has ballooned, globally.  And central bank money printing and backstops have been globally coordinated.
It all works until global coordination fractures.
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