Fed and RBA monetary policy post-SVB
Plus, the US February CPI; updated Q4 output and NGDP gap estimates; and why some columnists keep getting it wrong
There has been a dramatic re-pricing of the near-term monetary policy outlook in the US and Australia in the wake of the SVB failure and other problems in the US and EU financial systems. In the US, Fed fund futures have dialed back expectations for the 22 March FOMC meeting from a 50 basis point tightening to 25 basis points at best. A probability of 41% is now given to the Fed funds rate being held steady next week.
In Australia, a tightening at the April RBA Board meeting was fully priced out during the week, with only a residual 7% chance given based on Friday’s IB futures close. The SVB failure reinforced pre-existing sentiment for a near-term pause in the RBA’s tightening cycle. The IB futures strip is mostly flat beyond April.
These developments have seen some the biggest single day declines in short-term bond yields around the world in decades:
Source: FT
Contrary to this piece in the FT, these moves can’t just be laid at the feet of hedge funds being caught short fixed income. Price action in other markets is interpreting the risks around the financial system and its macroeconomic implications fairly consistently. The oil price is down. Even BTC has recovered its former safe-haven status. BTC-AUD is now up nearly 69% YTD. You know things are (potentially) bad when crypto is a safe-haven.
For a very concise take on why SVB failed and what its means, see Thomas Hoenig’s piece. This remarkably timely paper suggests that SVB may be more representative of the US banking system than we would like.
Then Assistant RBA Governor Guy Debelle gave some remarks on 14 October 2014 which were prescient in questioning whether markets were appropriately compensating risk-taking around future interest rate volatility. In an extraordinary coincidence, the US Treasury market experienced a flash crash the next day, although the crash was in terms of yield rather than price, the opposite direction to the one Guy was worried about. But a volatility event nonetheless.
He gave a fuller speech around this topic in 2018 at the Macquarie Financial Risk Day, at which I was also a speaker:
I find it puzzling that there is little compensation for duration in the rate structure. While there are explanations for why interest rates may remain low for a considerable period of time, there is minimal compensation for the uncertainty as to whether or not this will actually occur. At the same time, equity prices embody a view of the future that robust growth can continue without generating a material increase in inflation. Again, there is little priced in for the risk that this may not turn out to be true.
This was all very prescient, if more than a few years early. The only thing missing from Guy’s analysis was the role of monetary policy in these outcomes. Persistently low interest rates and inflation should have been a heads up that pre-pandemic monetary policy was too tight (one of the points I made at the same event in 2018):
The US February CPI and Australia’s Q1 trimmed mean inflation rate
The failure of SVB completely overshadowed what was previously expected to be a pivotal US February CPI release. In the event, Fed fund futures were left little changed on the day by an as-expected headline CPI outcome of 0.4% m/m and 6% y/y compared to 6.4% in January.
Source: Cleveland Fed.
The Cleveland Fed’s trimmed mean came in at 0.5% m/m and 6.5% y/y compared to 6.6% y/y previously. The slight moderation over January’s 0.6% m/m rise is enough to lower our forecast for the Australian Q1 trimmed mean from 1.7% q/q to