Pro Perspectives 8/8/23






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August 08, 2023

Last week, Fitch downgraded U.S. debt.  This morning Moody’s downgraded some banks.

It seems that the fragility of the banking system was well exposed three months ago, when some noisy venture capitalists decided to incite a run on Silicon Valley Bank.

The heavy concentration of uninsured deposits was exposed.  The duration mismatch was exposed (which all banks have, to varying degrees).  But more importantly, they exposed the vulnerability of the banking system to bank runs, from social media-driven mob behavior.

Of course, the shock in the banking system was quickly resolved.  And once again, it was resolved by Fed intervention.

With the above in mind, given the credibility problem these ratings agencies have, and given that the most powerful central banks and governments in the world have spent the better part of the past fifteen years fixing and manipulating markets where they see fit, do these downgrades matter?

If we look to the market reaction, thus far, for answers, it’s a maybe.  Stocks have given up ground since the Fitch downgrade (2% in the S&P, 3% in the Nasdaq).  And the 10-year yield jumped from sub-4% to as much as 4.20% over just a few days.

As for this downgrade of banks, Moody’s cites “funding costs” as a concern.  With the Fed Funds rates having gone from zero to north of 5%, one would expect at some point, the banks would relent and start paying interest to depositors (or lose them to the Treasury market).

With that, the cost of capital is rising (finally) for the banks.  And it’s contributing to tightening credit conditions reported in the recent Fed Senior Loan Officer Opinion Survey (SLOOS).

For the Fed, who have been looking for signs of “lag effects” from their tightening campaign, these downgrades might be among the effects.

On that note, we have the Kansas City Fed’s economic symposium in Jackson Hole, later this month.  This annual event is well attended by the world’s most powerful central bankers and finance officials, and has a history of signaling policy adjustments.  Maybe it will be an “end of the tightening cycle” theme.

We had some very well-placed comments from a voting Fed member this morning, following the Moody’s downgrade, saying they “may be at the point where they can hold rates steady.”