IEI - Powell And Yellen Spook The Markets
2023-03-28 08:30:00 ET
Summary
- Hiking interest rates in the middle of a financial crisis has been done before, so what Fed Chair Jerome Powell did last Wednesday is not without precedent.
- We don’t have deflation now, but Powell is fighting inflation, which is rapidly falling. He is not worrying enough about the banking system, which would tighten credit and help him fight inflation.
- First, it was Credit Suisse’s shotgun wedding to UBS in the weekend after the SVB collapse. Now we have Deutsche Bank, the largest bank in Germany, under pressure.
Hiking interest rates in the middle of a financial crisis has been done before, so what Fed Chair Jerome Powell did last Wednesday is not without precedent. In 2011, Jean Claude Trichet, the President of the European Central Bank (ECB) at the time, hiked their equivalent “Fed funds rate,” only to reverse course and take rates negative as threats of deflation and a misfiring financial system crippled the eurozone.
We don’t have deflation now, but Powell is fighting yesterday’s enemy, inflation, which is rapidly falling. In my view, he is not worrying enough about the banking system, which would tighten credit and help him fight inflation. Some economists estimate that the present tightening of credit of smaller banks that are on the ropes is probably the equivalent of a 100 basis point rate hike, making the Fed’s actions last week glaringly tone-deaf and completely unnecessary. Others think this credit crunch feels like more than a 100 bp Fed funds rate hike. In reality, no one really knows, other than to say that it is quite meaningful.
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
To make matters worse, former Fed Chair Janet Yellen walked back her comments on bank deposit insurance right in the middle of the FOMC press conference, causing a violent whiplash in both stocks and bonds. The trouble is, prior to the Wednesday incident, she tried hard to imply that the federal government is considering raising the cap on deposit insurance, so she had more or less convinced investors that such a move was coming. Given Powell’s unnecessary rate hike and Yellen’s foot-in-mouth comments, the two of them may very well have done more damage than Trichet’s untimely tightening of ECB monetary policy in 2011. We’ll know more in 3-6 months.
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
The good news is that in a week of unnecessary monetary policy tightening, the Fed’s balance sheet grew by a tad over $94.4 billion, putting the total Federal Reserve balance sheet growth at around $393 billion in the two reporting weeks since this banking crisis started. Since this is delayed data and there are other programs that aid banks with rapid outflow of deposits, it is fair to say that there has been about $500 billion injected into the banking system in a little over two weeks.
This liquidity injection is not inflationary, as the outflows become inflows to bigger banks, which in turn end up parking them in the Treasury market. The 2-year note declined further this week to touch 3.56% and closed at 3.77%, lower than last week, but after a Fed rate hike. Since this short-dated Treasury bond is one of the most sensitive to Fed policy, the bond market is screaming in “Jean-Claude” Powell’s face.
Apparently, he is not hearing the message.
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
Powell wants to save his legacy and not end up like the 1971-78 “asleep-at-the-switch” Fed Chairman Arthur Burns, but if this banking crisis ends up spreading like wildfire, he may end up with a historical reputation quite a bit lower than Burns’. The volatility in the bond market, which is clearly visible to those that keep an eye on Treasury futures, is as high as what we had in the 2008 Great Financial Crisis, as measured by the ICE BofA MOVE Index. I know that most individual investors don’t follow Treasury futures, but it is easier to understand the brutality of the move if we compare it to the S&P 500 Volatility Index (VIX): the swings are as bad as if the VIX were near 80. Yet, the VIX closed Friday below 22.
On Friday morning, word spread that Deutsche Bank ’s ( DB ) credit default swaps had jumped, so this banking crisis is spreading across Europe after spreading across the ocean. First, it was Credit Suisse’s ( CS ) shotgun wedding to UBS in the weekend after the SVB ( SIVB ) collapse, done in the spirit of JPMorgan ( JPM ) and Bear Stearns' $2 initial takeover bid. Now we have the largest bank in Germany under pressure.
It was truly bizarre not to have a pinch of stress in the Dax futures an hour before cash trading started and then see the Dax dive quickly by 2.5%. Deutsche Bank is in much better shape than Credit Suisse and roughly three times bigger in assets, and the German government will not let DB fail. As of this writing, I am not sure what caused DB’s credit default swaps to jump. It could simply be investor skittishness in the present environment, causing a 2.5% dive in the major stock benchmark in Germany last Friday morning.
Stay tuned for more answers next week.
Navellier & Associates Inc. does not own Silicon Valley Bank ((SIVB)), Deutsche Bank ((DB)), JPMorgan Chase & Co. ((JPM)) or Credit Suisse ((CS)) in managed accounts. Ivan Martchev does not personally own Silicon Valley Bank ((SIVB)), Deutsche Bank ((DB)), JPMorgan Chase & Co. ((JPM)) or Credit Suisse ((CS)) .
All content above represents the opinion of Ivan Martchev of Navellier & Associates, Inc.
Disclosure: *Navellier may hold securities in one or more investment strategies offered to its clients.
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Powell And Yellen Spook The Markets