- If US economic data stays strong ahead of the Fed’s 22nd March meeting, will Chairman Jerome Powell’s ‘faster tightening’ pledge still be honoured? We look at what the US bond market is signalling.
- Raising rates to stem inflation or settling banking sector jitters in the wake of SVB’s collapse? What will the Fed’s near-term priority now be?
- Can the Fed maintain its hawkish stance on rates amid market nervousness in the wake of SVB’s collapse? Why the tone of the FOMC’s meeting on 22nd March now matters more?
Key fixed-income metrics were broken in early March when the 2-year US Treasury yield rose above 5% while the 2yr-10yr part of the yield curve inverted by more than 100 basis points. The slope of the curve ultimately reflects the stance of monetary policy, and the policy implied by this move was that more rate hikes are on the way. And history pointed to an economic contraction pending. The yield curve has been a good predictor of previous recessions and tends to signal an eventual unwind of carry trades within the financial system or economy.
Past performance is not an indication of future performance
Source: Bloomberg as of 12 February 2023
The US 2yr-10yr curve hit its most inverted level since the early 1980s in response to aggressive rate rises by the US Federal Reserve (Fed) and continued hawkish comments from its Chairman Jerome Powell. In his 8th March testimony, before the Senate Banking Committee, Powell explained that recent economic data had been stronger than expected and that ‘the ultimate level of interest rates is likely to be higher than previously anticipated.’ He went on to add that ‘if the data were to indicate that faster tightening is warranted, we would be prepared to increase the pace of rate hikes.’
As we wait anxiously for the Fed’s rate-setting committee to meet on 22nd March a new consideration has been hurled into the mix, the failure of Silicon Valley Bank (SVB). If the Fed maintains its hawkish stance and hikes rates by 0.5%, fears of more banks coming under pressure will increase and, in the markets, we will need to brace for a period of heightened volatility. The market has seen a few days of substantial pricing-out of Fed hike expectations and the yield curve has steepened by a whopping 50 basis points (-110bps to -60bps) since last Wednesday.
In the wake of SVB’s collapse the Fed has set up a new emergency facility to let banks pledge a range of assets for cash. Regulators have pledged to fully protect depositors at the Bank.
Fed speakers are now in a blackout period and unable to offer any commentary. We maintain a tactical overweight to Gilts and Treasuries in our portfolios.
