How Credit Suisse just triggered a nightmare decision for the Fed and ECB

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Thursday March 16, 2023

Today’s newsletter is here Jared Blikre, a reporter focusing on the markets at Yahoo Finance. Follow him on Twitter @SPYJared. Read this and more market news on the go with the Yahoo Finance app.

Credit Suisse (CS) just had its worst day on record – the stock plunged 22%. The bank’s bonds are also falling, and investors are paying to insure their bonds at rates not seen since the global financial crisis.

As investors question the solvency of one of Europe’s largest banks, the safety and soundness of the entire global banking system is once again a big question mark for Wall Street. Meanwhile, investors in the US are still grappling with the aftermath of the collapse of Silicon Valley Bank and Signature Bank, which sent regional bank stocks down for the seventh time in eight sessions.

The once daunting task facing Federal Reserve Chairman Jay Powell and his fellow central bankers has become a seemingly impossible dilemma – continue their fight against inflation by raising interest rates and tightening credit markets even further, or one tackle a new banking crisis that harbors systemic risk.

Recall that just last week, Fed Chairman Jay Powell sat before Congress and said the Federal Reserve was “ready to increase the pace of rate hikes.” He hedged the statement (as a conservative central banker should), citing the need to consider the “all of the data coming in”.

But the bond market took notice that day, as did bank stocks. Suddenly, markets are pricing in a 50 basis point (0.5 ppt) rate hike in March instead of 25 basis points. The US 13-week Treasury Bill (^IRX) yield rose the most in two months — above 4.8% for the first time since 2007. Meanwhile, the S&P 500 Select Financial SPDR ETF (XLF) had its worst day in nearly six months, settling at a six-week low.

From there, banks went on a week-long slide that wiped out billions in market cap values.

Whether or not Powell’s visit to the Capitol last week was the proverbial straw that broke the camel’s back, he and his fellow central bankers face a monster decision next week with tough choices and no ideal solution.

Chicago Booth professor of finance and former Reserve Bank of India governor Raghuram Rajan joined Yahoo Finance Live to explain the difficult decisions the Federal Reserve now faces in the face of its twin problems of persistent inflation and banking instability.

Rajan says the Fed will likely choose between a 25 basis point hike and a standstill, leaving rates where they are. (As of Wednesday afternoon, bond futures assign equal probabilities to both.)

“I doubt they’ll cut,” says Rajan, who also says a more aggressive 50 basis point raise is likely off the table. “That would be a pretty tough hike at this point when you have that much fragility,” he added, “the question is 25 or zero [basis points].”

If the Fed holds short-term rates steady, Rajan expects Powell to downplay investor perceptions that the Fed is “on pause” for several meetings.

Historically, the Fed has not changed the direction of its rate policy all that often, and market participants may be left with the impression that future rate hikes are off the table. That could jeopardize the Fed’s credibility in fighting inflation and its perceived determination to hike rates again if inflation persists.

Rajan says if the Fed doesn’t hike, it will use “very strong language” to protect itself, saying “we’re not taking a break.” We’re just pausing and seeing markets calm down,” he adds, adding the Fed would keep the window open to continue tightening.

Conversely, if the Fed hikes 25 basis points, it suggests the Fed is still concerned about inflation and the need to slow the economy. However, this option risks further freezing credit markets and deepening cracks in the financial system. (Remember what happened when Powell just spoke a hawkish game last week.)

It may seem counterintuitive, but the Fed can still theoretically achieve its goal of curbing inflation not moving short-term rates next week. First, imagine a business owner or C-suite executive overseeing current issues in the banking sector. Many see a recession on the horizon and decide to lay off workers, slowing the economy.

“The turmoil in the financial sector will do some of the Fed’s work. Well, that’s not the ideal way to do the Fed’s job. But it can be part of it [it]’ says Rajan. If the Fed thinks the crisis is bad enough to do its dirty work, that would tip the Fed toward zero, he explains.

“It’s all up in the air [and] very confusing,” says Rajan.

Bottom line, it’s a big dilemma.

If the Fed doesn’t move, it risks damaging its hard-won anti-inflation credibility mid-fight.

If the Fed hikes, it could exacerbate deteriorating credit market conditions and contaminate the “productive” parts of the economy.

At the very least, Powell has a week to digest evolving situations at home and abroad. His European colleagues must act this morning. decisions decisions.

What to see today


  • building permitFebruary (1.238 million annualized rate vs. 1.339 million in January)

  • living beginsFebruary (1.31 million annualized rate vs. 1.309 million in January)

  • Initial jobless claims (205,000 expected vs. 211,000 last week)

  • Philadelphia Fed Manufacturing Survey


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