A Bank, the Fed, a Ceiling and the (short-term absence) of Fear, George Lagarias, Mazars

by | May 2, 2023

George Lagarias, Chief Economist at Mazars comments: “Another week, another regional bank failure. First Republic, a 37-year-old bank from San Francisco became the third US regional bank and fourth in a row to fail (including Credit Suisse). Apart from the actual day of the failure, curiously a Monday as opposed to the classic Friday, there isn’t much to write home about. First Republic had been on life support since the week after SVB’s failure, with slim chances of recovery. The Federal Deposit Insurance Company (FDIC) stepping in was simply the signing of its official death certificate.

“When rates are high, smaller lending organisations may fail. It’s part of the game. SVB and Signature have gone under and First Republic followed. And while it is the really problematic entities that failed, the pressure continues throughout the US banking system, with peripheral banks still heavily using the Fed’s discount window.

“The fact that the bank was allowed to fail on a Monday instead of a Friday (which would give markets some time to digest the news) suggests that regulators didn’t fear a market backlash. On Monday (the US market was open) stocks barely moved on the news, ending the session nearly flat. The yield on the US 10-year bond inched upward, of course, but not significantly.

“The market still expects the US central bank to go ahead with at least one more rate hike. What will be infinitely more important this time around, is the statement, where Jay Powell’s policy team is expected to provide some guidance as to their intentions regarding further rate hikes. Whereas the bond market isn’t pricing in any further tightening, strategists in Wall Street expect that the Fed, which has already acknowledged that credit conditions are tighter, could squeeze in one more hike until pausing. That means that the Fed remains undaunted by bank failures (after all, these happen), or even the fact that interest rates will now be higher than actual inflation for the first time in years bar the pandemic.

“And with all that happening, we are closing in on the much-anticipated debt ceiling fight in US Congress. The fact that the Dollar steadily loses ground against gold and perhaps other currencies as a global reserve goes largely unnoticed in the Capitol of the world’s biggest economy.

“Bond markets remain by and large unperturbed. Lawmakers have threatened us with the debt ceiling so many times, why should this be different? The previous administration’s decision to loosen regulations for smaller banks arguably contributed to the present peripheral banking crisis. So did the (at the time logical) decision to give big checks to all Americans during the pandemic, which led to higher inflation and inescapably higher interest rates. And the question is, should we be fearful when it’s policymakers that are greedy and not so much the markets? Historically, the answer is yes but over the longer term. Congress and the Fed have ways to mitigate a debt default if it causes a crisis. And the central bank can always print money and reduce rates if the market is collapsing as a result of a self-induced crisis. Policymakers are bullish and take risks because they presume they have the power to fix the things they broke in their pursuit. But those fixes are usually short-term. This will be reflected on our short-term, tactical asset allocation.

“Over the long term, they tend to cause ripples far beyond what we can see today. Lack of trust in the world’s risk-free asset, the US Treasury, is bound to have long-term implications for investors. Banks breaking are bound to change consumer behaviour in ways unforeseen. These risks should be reflected on our long-term, strategic, asset allocation.”

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