by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Good morning! Today’s Comment begins with a discussion on why monetary policymakers are reluctant to articulate a coherent message on future policy. Next, we give our thoughts about a potential credit crunch. Lastly, we review the latest headlines coming out of Asia.

Is Tightening Over? Sticky inflation and slowing economic growth have central bankers divided on future rate hikes.

• The failures of Silicon Valley Bank (SIVBQ, $0.57) and Signature Bank (SBNY, $0.15) in March have prompted several Fed officials to push for a rate pause. Minutes from the central bank’s March 21-22 meeting showed that policymakers were concerned that the banking turmoil could spread throughout the economy. Despite Federal Reserve officials having confidence that the banking system was sound and resilient, Fed staff predicted that the crisis could lead to a recession in late 2023. That said, the committee still voted unanimously to raise rates by 25 bps as members concluded that the emergency lending program sufficiently solved the bank run problem.
• The U.S. banking crisis and the collapse of Credit Suisse (CS, $0.92) led several European Central Bank policymakers to rethink the need to raise rates further. ECB Vice President Luis de Guindos and Governing Council Member Pablo Hernández de Cos have insisted that rates need to rise to help get inflation to its 2% target. However, both policymakers were unsure whether the ECB should raise its benchmark rate at its next meeting. The central bank’s reluctance to commit to further rate hikes reflects the hesitancy of policymakers in a time of heightened uncertainty.
• There is still palpable fear that the financial system has not fully recovered. The indecisiveness regarding the path of future hikes suggests that officials are close to implementing a pause. That doesn’t necessarily mean that the central banks will stop anytime soon. Austrian Central Bank Chief Robert Holzmann is pushing for the ECB to raise rates by 50 bps. Meanwhile, St. Louis Fed President James Bullard insists that the Fed should keep raising rates while the labor market remains strong. Overnight index swaps for the EUR and the USD show that the market expects central banks to raise rates at least one more time this year.
  • On a related note, new Bank of Japan Governor Kazuo Ueda has stated that he is in no rush to tighten policy. Meanwhile, the Bank of Canada paused rates in its latest meeting but may raise in the future.

Credit Crunch: Signs of a credit crunch have led the government to develop more safeguards to protect the public from any financial fallout.

• There is a growing debate about whether the drop in bank lending reflects tightening lending standards. Fed data showed that U.S. commercial bank lending fell by $105 billion in the two weeks ending March 29. Analysts at Goldman Sachs and Treasury Secretary Janet Yellen attributed the decline to the transfer of assets from failed banks Silicon Valley Bank and Signature Bank. In contrast, Lael Brainard, head of the National Economic Council, stated that she is seeing signs of banks pulling back credit. The discussion over lending has added to worries that the banking system may still need assistance.
• The lack of lending may be related to financial institutions preparing for extra scrutiny of their lending practices. European regulators are working on a plan that would complicate government efforts to inject liquidity into struggling banks. In the U.S., a recent survey showed that there is bipartisan support in favor of restoring bank regulations that were repealed in 2018. At the same time, Bank of England Governor Andrew Bailey warned that potential reforms to increase guaranteed deposits will have cost implications for banks.
• Investors are worried about potential hangover effects from the banking crisis. Despite the rebound in investment grade bonds, investors are wary of junk bonds. The lack of risk appetite reflects growing fears of an incoming recession, particularly in the U.S. Although a downturn is widely expected in the Eurozone and U.S., factory output data suggests that the EU may be better positioned. When combined with a weakening dollar, we suspect that there may be attractive opportunities outside the U.S. So far this year, the Euro Stoxx 50 has outperformed the S&P 500, 12.95% to 7.05%.

Asia in Focus: There are new risks developing in the Indo-Pacific region, but we remain optimistic.

• Several Asian countries have reported a substantial jump in COVID infections; however, this outbreak remains contained at this time. Singapore, India, Indonesia, and Vietnam have all reported yearly highs in their number of cases. The latest strand, known as the Kraken variant or XBB.1.5, is viewed as a highly transmissible omicron strain but with relatively mild side effects. Hospitals have been able to manage the caseloads so far, but governments are still looking to take more preventive measures. For now, we do not expect this new wave to lead to major supply chain disruptions, but it is something we will be monitoring.
• North Korea fired a new type of intercontinental ballistic missile on Thursday. The launch triggered a scare in northern Japan as residents were told to take shelter. There were no casualties, but the launch reflects North Korea’s improvement in its weapons capabilities and its growing assertiveness. Additionally, the provocative act will put pressure on Japan to ramp up its defense expenditures as it looks to protect itself from rivals. The Japanese government plans to double its military budget within the next five years and may be encouraged to increase it even further. The new military spending should benefit U.S. aerospace and defense industries as Tokyo may seek to collaborate with Washington to meet its ambitious target.

• On a positive note, China’s need for economic growth may lead it to moderate tensions with the U.S. On Thursday, Beijing announced that it would scale back its no fly-zone over Taiwan to 27 minutes, after initially notifying Taipei that it was planned to last from April 16-18. Although the Taiwan protests helped, the move may reflect a temporary thaw in U.S.-China tensions. Recently, government officials from Washington and Beijing have made comments in favor of the two countries maintaining ties. Although the relationship between the two countries will continue to be rocky, we believe that China may be a desirable investment destination for risk tolerant investors in the short to medium term.
  • The recent surge in Chinese exports (see previous chart) reflects its need to bolster its GDP after it lifted its COVID restrictions.

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