The hot take on why a 100-basis-point rate rise from here simply can't be dismissed after the Silicon Valley Bank exhale and may put Charles Schwab Bank on the hot seat
Following the recent banking panic, rates seem to be finally experiencing 'some stickiness,' but too many unknowns and uncontrollable factors remain before economists can breathe easy.
4 min read- Inflation's stickiness, unrelated to typical factors, may force further Fed rate hikes.
- System-wide hedging against higher rates is impossible; someone must hold long positions.
- SVB's failure wasn't solely mismanagement; systemic vulnerabilities exist.
- Rising JGB yields could destabilize Japanese regional banks.
- Taiwanese life insurers' currency hedging on US debt holdings remains a key unknown.
Brooke's Note: Sometimes the best answers to a reporter's questions arrive like light from a distant galaxy – chronologically late but shining with a brilliance that makes the timing beside the point. I needed a source for our March 29 article about Schwab's new reality. The company is beset with billions of dollars in unrealized losses and a share price Wall Street adjusted downwards in response. I called the best big-picture markets and economics source I know, Jeffrey Young, co-founder and chief economist of DeepMacro. He responded after returning from Asia and recovering from the jetlag. I had asked him to respond to Jon Holtaway's assertion in the article that Schwab could be in danger of losing its bank subsidiary if rates leap another 100 basis points. When I covered banks in Baltimore, Holtaway was a star analyst, and his views can't be dismissed out of hand. Is it actually conceivable? After all we've been through with rates, could the cost of money leap another full percentage point? And, if so, what catalysts – both plain vanilla and Black Swan – might precipitate the painful rise? I decided that everyone in the financial industry would want to hear Young's answer to the $10-trillion question because his response is both interesting and freighted with potential consequences.
The answer to your question: Of course, either short-term rates or longer-end yields could go up significantly.
The most obvious reason is that inflation fails to move down. We have been very bullish that inflation will fall...but probably too bullish.
There is some stickiness. I am sure that you are getting hit with price increases even now, where plus-5% is the new flat. The factors I am seeing have absolutely nothing to do with energy, Ukraine, pandemic distortions, or any other "special factors" that have allegedly been pushing up inflation.
They simply reflect an inflationary psychology and behavioral pattern. If this is really deeply entrenched, then the Fed will have to keep raising interest rates, and there you have your scenario.
Mind you, I think this is just a risk -- I think growth is slowing and inflation is slowing -- but it has not been as fast as I thought it would be, so it is fair to say that there is something there.
Schwab assures it has financial muscle to shrug off billions of dollars in unrealized bank losses, but interest rate blunder exposes vulnerability if Fed hikes continue, analysts say
Referring to your "Black Swan level" event: again, sure. There can be market dynamics where people have to sell once certain thresholds are triggered, due to derivatives and the like.
If anyone took the Fed or academics seriously and believed, as they say, that Silicon Valley Bank (SVB) was a ‘textbook case of mismanagement,’ and decided, 'Hey, let's not be a chapter in that textbook, let's hedge our risk'... what happens then?
Rates are really going up.
What works for one firm might not work for the system.
Story Timeline
This is why the idea that SVB was simple interest rate mismanagement is wrong:
Walt Bettinger comes out swinging during analysts' call, and shares pop, on assurances Schwab can ride out gale force interest rate pressure on its balance sheet
(1.) the entire system cannot hedge against higher rates. It would be selling to itself. Somebody has to be long interest rates.
(2) Run with the 'they should have hedged' logic for a minute. Wait -- so a $250-billion bank is supposed to sling its balance sheet around like a hedge fund? Supposed to go limit long (under QE and zero rates) to all the way short (under soaring inflation and higher rates) in the space of a few months?
This in itself would both increase interest rates, and probably raise the attention of regulators, who would say: ‘Why are you changing your trading book so fast?’
It's easy to point out the flaws in any individual bank's decisions, but it does not follow that if only that bank had done things differently, we would not have any problems.
Just see what happens to the Japanese regional banks if JGB (Japan government bonds) yields go up appreciably!
Taiwanese life insurers own at least 20% of the US corporate debt market and a lot of Treasuries. Nobody really knows how hedged they are on the currency.
Jeffrey Young is co-founder and chief economist for DeepMacro, which provides investors and policymakers with an automated, real-time view of the global macroeconomy, combining traditional data sources with novel "Big Data" and applying these insights to markets.
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