Banking Sector Woes Distract Markets From Fed’s True Monetary Policy Intent

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Eurozone Market Update

Despite the recent market turbulence caused by Silicon Valley Bank (SVB) and Credit Suisse (CS), the ECB stuck to its forward guidance by raising all interest rates by 50 bps, taking the deposit rate up to 3%. While driven by elevated inflation, the decision was not unanimous, with three to four members advocating for a wait-and-see approach. There was a doveish change of tone on forward guidance, with the governing council stating: “The elevated level of uncertainty reinforces the importance of a data-dependent approach to policy rate decisions”. The ECB also underlined that rate rises are focused on combatting inflation and that many other tools exist in its extensive liquidity facilities to tackle any market fallout from the recent banking turmoil.

UK Market Update

In line with market expectations, the BoE hiked 25 bps in March after UK inflation (10.4% headline, 6.2% core) came in higher than expected. The rise took the base rate to 4.25%. The voting pattern was interesting, given the divergence of views expected following the US regional bank woes and the takeover of CS. The vote split – 7 for a 25 bps hike and 2 for no change – was perceived as hawkish. However, it should be noted that Catherine Mann, a member of the BoE’s Monetary Policy Committee (MPC) and previously an advocate for 50 bps hikes, voted for a 25 bps hike, providing further evidence that the MPC is moving towards a pause. The vote split and statement suggest that future BoE rate decisions will be data-dependent.

US Market Update

Following a tumultuous fortnight in global banking markets (see Chart of the Month), the Federal Reserve’s FOMC raised interest rates by 25 bps in March. The FOMC’s policy statement noted that recent concerns about the banking sector were “likely to result in tighter credit conditions … and to weigh on activity, hiring, and inflation.” Fed Chair Powell remarked that, if persistent, such tightening of credit conditions could, in effect, reduce the need for policy rates to rise much further. At this meeting, policymakers unanimously approved the increase because economic activity and inflation data had surprised to the upside. While futures markets have multiple 25 bps rate cuts priced in for this year, Powell noted that no policymaker saw a cut this year as appropriate.

Looking Ahead

The banking sector turmoil has muddied the monetary policy outlook. The subsequent tighter financial conditions have introduced uncertainty over the path of policy rates for the rest of the year. For example, the market believes the FOMC will soon start cutting rates. However, we are not convinced. To us, the future path of monetary policy remains highly dependent on incoming data. Barring a further tightening of credit conditions, we don’t think the FOMC is quite done raising rates yet, and rate cuts remain unlikely this year. In the UK, we expect a final 25 bps hike by the BoE in May, followed by a prolonged pause, although this is not a done deal. However, we strongly disagree with the market view that the BoE will begin a rate-cutting cycle as early as September 2023. Ultimately, we are exercising caution in all regions and maintaining a duration-neutral stance until greater clarity on the inflation path and banking system stability is confirmed.

Chart of the Month: March's US banking turmoil had a clear impact on the market's rate expectations

_{Source: Bloomberg. As of 31/03/2023}

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