Rising Interest Rates Hurt – Who Knew ?

• Strong US policy response to the demise of SVB – but watch the macro-financial transmission channels
• Central banks are less united on their stance. We see the ECB to hike by 50 while the Fed should stay at 25 – while the Bank of Canada chose to pause.

The US authorities took out the “big guns” and acted decisively before the market open to contain the spillover effect from the demise of SVB (now accompanied by Signature Bank) using a two-pronged approach. First, they will “make good” on these banks’ deposits beyond the normal FDIC insurance limit. Second, the Fed has launched a new program ensuring access to 1-year liquidity at favourable terms: the par value, instead of the market value, will be used to assess collateral – providing relief against the shrinkage of the banks’ bond portfolio - and no “haircut” will be imposed. This should stem a potentially disruptive migration of deposits from small to mid-size banks to large, systemic ones. Beyond the immediate financial stability issue, the SVB episode sheds a light on the not-so-straightforward impact on higher interest rates on banks, especially when variable rate liabilities collide with fixed-rate assets accumulated at historically low yields. This is another reason to be quite attentive to macro-financial developments as a potential harbinger of difficulties in the real economy. The SVB episode is also likely to trigger more prudence at the Fed in the field of monetary policy. In any case, there was just enough softness in the payroll data last Friday to stop the Fed from resuming “jumbo hikes”. Unless this week’s CPI comes noticeably above expectations, 25 bps should remain the pace until a terminal rate which we see at 5.50% is hit in June.

We’ve been arguing for several weeks that the ECB should pay more attention to the collapse in the credit impulse, but our impression is that the Governing Council will remain focused on the message from core inflation in the definition of its trajectory. Even if Christine Lagarde may try not to elaborate too much on the quantum of the next moves after delivering this week the well-telegraphed 50 bps hike, given the overt disagreements within the Council, the direction of travel is clear – and it’s up. Since we expect robust core inflation over the entirety of the first half of 2023, a terminal rate at 4% would not surprise us much. The ECB would be at the hawkish end of the distribution. Other central banks, such as the Bank of Canada, also focused on the recent core inflation trend, are now pausing.