ILCB - The '70s Playbook
2023-03-20 11:15:00 ET
Summary
- Now that their interest rate policy is starting to cause things to break, the Fed can continue to raise interest rates and watch the systemic risk to the system increase or cut interest rates and watch inflation explode.
- I expect them to raise rates one more time, but eventually they will choose to save the system. They will choose financial stability. They will choose inflation.
- While this banking crisis looks ugly, it does have a silver lining - it should help bring down inflation.
The Fed has a decision. Now that their interest rate policy is starting to cause things to break, they have two choices - both of which are bad. They can continue to raise interest rates and watch the systemic risk to the system increase or cut interest rates and watch inflation explode. I expect them to raise rates one more time, but eventually they will choose to save the system. They will choose financial stability. They will choose inflation. It’s politics.
While this banking crisis looks ugly, it does have a silver lining - it should help bring down inflation. The banks will become more cautious about lending, which will lead to a tightening of credit standards. This, in turn, will make it more difficult for small businesses to access credit, which will potentially lead to higher unemployment, slower economic growth and lower asset prices. This will go a long way towards fighting inflation.
“CPI doesn’t really matter. What happened over the last 3 days has done Powell’s job for him. Credit creation at banks will collapse & the economy will slow. Inflation will taper off as a result. Any rally on the view that the Fed doesn’t need to raise anymore is silly. If they don’t raise, it’s because of systemic risk to the banking system. Not a positive.” - JPMorgan
It won’t, however, cure us of the inflation bug. The Fed will not be able to raise rates high enough to squash it. This is why this is a 10-year fight on inflation will come in waves. We will invest accordingly, and this will include a good amount of tactical movement as asset classes fall into and out of favor.
We have told people in conversation that we felt that Credit Suisse ( CS ) was next. Probably not something you should write down and quite irresponsible - to tell you the truth. Finance is all about confidence. Runs on the bank only happen because people have lost faith in that bank. How did we know CS was next? Their Credit Default Swaps (CDS) were trading up-front. That was the death knell. Bottom line - that means everyone had lost faith in them and did not want to do business with them. They were a dead bank walking. Lots of rumors, as the deal is still in motion but CS will probably be gone by Monday morning. There will be repercussions felt. The next problem is going to be Commercial Real Estate. Small to mid-size banks do 80% of all commercial lending. Credit is going to tighten up. Some firms that hold large mall or office space are fighting for their lives. I know of one large name that has CS as its biggest tenant. The dominoes are not done falling.
The playbook from the '70-'80s says to sell on the last rate hike, which should come this week. However, the playbook from the last 20 years says buy the last rate hike. I think we go with the '70s playbook.
This bank problem can fix itself somewhat. Banks are long assets that will rise in price if rates come down. That will help their balance sheet. This is a problem caused by the Fed. They have the power to end it if they don’t let it get out of control. Understand that the Fed wants stocks to go lower to restrict financial conditions to bring down inflation.
Recession is here. The Fed will raise rates again next week to show commitment and strength. If they don’t, then everyone assumes we are in deep trouble and panic resumes. It will be the last rate hike for a while. Weekends are going to be important now, especially holiday weekends. Banks can blow up, but central banks can act / cut rates. Emergency rate cut would send markets soaring first before falling.
When Bear Stearns failed, markets rallied at first, then went lower. Lehman fell months later. Things are now happening in days. If we break 3800 on the S&P, we go to 3400 very quickly.
Disclosure: This blog is informational and is not a recommendation to buy or sell anything. If you are thinking about investing consider the risk. Everyone’s financial situation is different. Consult your financial advisor.
Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.
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The '70s Playbook