Pro Perspectives 3/15/23

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March 15, 2023
The confidence shock in U.S. banks spilled over to an already fragile Swiss bank today.
Credit Suisse was already a very wounded bank, a fraction of its size and status of fifteen years ago. 
But it’s still important enough to stabilize (important to the preservation of stability in the European banking sector – and global importance, to a degree).  With that, the Swiss central bank (SNB) stepped in by the end of the day with liquidity support. 
This, again, highlights a big difference between the current environment, and 2008.  We know, without question, that the global central banks will act quickly, and in coordination, if needed, to maintain stability.
Will there be more dominoes (more trouble)?  Maybe.  Will they (the central banks) do more, if needed.  Yes.  “Whatever it takes.”
That said, the longer the uncertainty exists around the size and scope of this fallout – which started with a bank run on a niche Silicon Valley bank – the greater the damage will be to the economy.
With a shake-up in the banking sector,  we should expect credit to tighten.  When credit tightens, job creation slows.  When these two things happen, consumption slows.
Let’s hope it’s all short-lived and done out of caution.  Nonetheless, it’s a deflationary formula.
This deflationary formula comes as the Fed was already very near the point of putting downward pressure on inflation, from its level of interest rates. 
Remember, historical bouts with inflation have been won by taking the Fed Funds rate ABOVE the rate of inflation.  In this case, the Fed’s preferred measure of inflation (core PCE) was last reported at 4.7%.  The effective Fed Funds rate is 4.58%.
It’s fair to say following the last Fed meeting, with a solid economy, the Fed was looking to raise two to three more times, as “insurance hikes.”
Those are no longer needed. 
The interest rate market is not only communicating that, but it’s pricing in more persistent deflationary pressures (pricing in a 60% chance of a few rate cuts by the end of the year).
As we’ve discussed in my daily notes often, we need inflation.  We need an inflationary boom (high growth, hotter than average inflation), where the unsustainable government debt-load can be inflated away by growth
Far worse than high inflation, is a deflationary bust (low or contracting economic activity and falling prices). 
A deflationary bust is vulnerable to a self-reinforcing spiral, and very difficult to escape (ask Japan).  And it’s far more dangerous, given that we’ve already exhausted two deflation-fighting tools:  government spending, and expansion of the Fed balance sheet.  
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