Dear Reader,
Bond markets, especially in the US, are large and deep, and daily movements in yields are usually restricted to a few basis points. But in the past couple of weeks, the yield on the 2-year US Treasury note yo-yoed from a multi-decade high of 5 percent on March 8 to 3.9 percent on March 13, to 4.25 percent on March 14, plunged to 3.8 percent on March 15 and edged up again. When US Treasuries behave like penny stocks and bond investors like headless chickens, it’s a sign of the world being on edge. This FT story, free to read for Moneycontrol Pro subscribers, talks of the strains in the bond markets this week. The MOVE index, which measures volatility in the US bond market, is at its highest since the Global Financial Crisis.
What’s more, the probability of the Fed not hiking rates at its next meeting was zero a week ago, 45.4 percent on March 16 and 15.1 percent on March 17 morning. The probability of a 25 basis point hike gyrated wildly during the last week.
In contrast, the move in the US Vix, a measure of volatility in US stocks, has been just a blip. Equity valuations are still not factoring in a regime change in financial conditions. Instead, they are looking to central banks to pause and ultimately reverse monetary tightening, which would result in liquidity being abundant once again and justify current stock valuations. As my colleague Aparna Iyer wrote, it’s a competition between who will blink first — the market or central banks.
As on Friday, the CME Fedwatch tool showed that markets are betting on the Fed hiking rates by 25 basis points this month, another 25 basis points in May, a cut of 25 basis points in June, and another cut in July that would bring back the Fed Funds rate to today’s level. By the end of the year, another 25-50 basis point cut is being factored in. Jerome Powell’s ‘higher for longer’ message has been thrown out of the window. A month ago, the markets expected the Fed Funds rate at the end of 2023 to be 5-5.25 percent. Now, the odds are evenly divided whether it will be 4-4.25 percent or 4.25-4.5 percent.
Of course, what has changed in the past one month is the crisis triggered by the collapse of SVB in the US and the contagion spreading to Credit Suisse in Europe. While regulators have hurried to prevent systemic risk — the Fed balance sheet has jumped since the crisis, as banks rushed to borrow from it — the outlook for bank profitability is rather bleak.
There are worries about a slowdown — the money supply in the US has been falling. Lower deposit rates offered by banks could lead to a steady outflow of deposits to money market mutual funds. And if banks raise deposit rates, their profits will be hit, which would mean lower earnings and share prices. Banks can also be expected to be more cautious about lending, although the crisis is limited to a few bad apples, rather than the whole banking barrel.
That might be exactly what central banks want. They have been trying to tighten financial conditions and slow down the economy. The banking panic will do the central banks’ work for them, allowing them to temper the pace of rate hikes.
That will also be a relief for central banks, as they are caught between inflation and financial instability. With the European Central Bank hiking its policy rate by 50 basis points in spite of the concerns over Credit Suisse, it’s a signal that central banks will ensure liquidity to beleaguered banks on the one hand, while keeping up the fight against inflation on the other. That was also the playbook of the Bank of England during the pension crisis in the UK — It ensured liquidity while continuing to raise interest rates. Indeed, our columnist Ajay Bagga points out that the market sell-off may be overdone, given that investor fears relate to bank liquidity, which the central banks are addressing, rather than solvency.
Nevertheless, a banking crisis is not the way any central bank would like to deal with inflation. What’s more, activist investor Carl Icahn has warned of stress beyond the financial sector, saying many companies had invested billions of dollars on flawed acquisitions and became over-indebted in the process. Time’s up for the zombies.
The bigger question is whether the decades-old regime of low inflation and interest rates and abundant liquidity, plotted and aided and abetted for decades by central banks in the developed economies, is finally coming to an end. The philosopher Antonio Gramsci’s quote, “The crisis consists precisely in the fact that the old is dying and the new cannot be born; in this interregnum a great variety of morbid symptoms appear”, although said in a very different context, is equally applicable for the markets today.
The contagion has spread to markets across the world and India is no exception. Foreign portfolio investors have built up record short positions in the Indian equity market. Luckily, the Reserve Bank of India doesn’t face any financial stability problems, although inflation continues to be stubbornly high.
The banking crisis is unlikely to cast a shadow on Indian banks. But it will be a struggle for India to reach 6 percent plus growth in FY24, as this piece points out. And the Indian start-up ecosystem will feel the tremors of the SVB collapse.
No wonder that in this scenario, the Indonesian central bank has paused rate hikes while the People’s Bank of China has cut its reserve ratio by 25 basis points to free up cash with banks for lending.
Few music albums reflect the current times better than Pink Floyd’s ‘Dark Side of the Moon’, which celebrates its 50th anniversary this month with a deluxe box set that includes remastered stereo versions of the iconic album, CDs and LPs of ‘The Dark Side Of The Moon – Live At Wembley Empire Pool, London, 1974’, a hardback photo book and memorabilia, to be released on the 24th of March. As the Wall Street Journal said of the original album, “The music is remarkably gentle and hypnotic, while the lyrics are of their time, examining such issues as madness, sadness, empathy, war, materialism and human existence.”
Here’s a song from their album -- Eclipse, with lyrics -- for your listening pleasure.
Cheers,
Manas Chakravarty
Here are some of the stories and insights we published this week, apart from our technical picks in the equity, commodity and forex markets:
Stocks
Persistent Systems, Ami Organics, Sagar Cements, TCS, Weekly tactical pick, Sirca Paints, ZF Commercial Vehicle Control Systems India, Navneet Education, Defence engineering sector, Hyderabad Industries, A leader of the auto ancillary pack, CCL Products, NOCIL
Markets
Is it time to lock into high yields?
Economy
Companies and industry
TCS, Infosys, Patanjali Foods, The Green Pivot—Thermax, Cipla, HUL gets a new chief, Tata Technologies IPO
Digital lending, Aatmanirbhar in defence, Semiconductor market, Hospitals sector
Banking crisis
Why the Fed had to step in to save SVB depositors
Why did the markets react adversely to the Fed’s moves?
SVB crisis stirs up memories of 2008 – What should investors do?
Financial Times
Nickel ‘alchemist’ Xiang Guangda aims to work his magic on batteries
SVB was only a little bit insolvent, luckily
SVB shows the perils of regulators fighting the last war
Others
Karnataka elections, Personal Finance—lessons for depositors from SVB collapse, Money laundering laws, The defunct economics that drives US monetary policy, The mysterious charm of Neiphiu Rio, The Eastern Window: Saudi-Iran deal
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