An important second order effect resulting from the collapse of Silicon Valley Bank (SVB) ...
An important second order effect resulting from the collapse of Silicon Valley Bank (SVB) together with fears of further bank contagion is the degree to which these concerns impact broader economic confidence. There is some concern that recent high frequency economic data releases are pointing to a rapid loss of momentum. The debate about the risk of a recession is once again on the agenda.
The beginning of 2023 saw a strong recovery in US labour market and other key economic lead indicators. This created some anxiety in the Fed that this recovery was too rapid, and this saw a tightening of their reaction function. However, since the SVB collapse economic data has subsequently weakened at a rapid rate resulting in a significant lowering in year end rate forecasts.
Chart 1: After a strong start to 2023 US data has started to rapidly deteriorate.
Chart 2 shows the status of bank lending standard surveys for both large and small firms. Lending standards have spiked and are at levels that have only been exceeded three times this century. Given that US non-financial corporates have accumulated corporate debt at a 7.7% CAGR since 2011 taking the total from c. $6tn to $13tna tightening in lending standards marks an important inflection point in this trend. Weaning corporates off debt accumulation and financial engineering would constitute a major paradigm shift.
Chart 2: Bank lending standards have soared – a paradigm shift?
Despite lending standards tightening and real M2 money supply remaining deeply negative our US composite Financial Conditions Indicator has continued to move from restrictive to neutral. This has been driven partly by declines in both bond yields and real yields. In addition, the dramatic decline in US interest rate expectations has seen US interest rate differentials (versus other G7 economies) narrow. This has contributed to the decline in the dollar as can be seen in Chart 3.
Chart 3: Narrowing US interest rate differentials have contributed to the decline in the dollar
Source: Wilshire, Refinitiv, Factset and Federal Reserve. Data as of April 13, 2023
Markets have been gripped by risk aversion since mid-August
Markets have been gripped by risk aversion since mid-August in response to hawkish Fed and global central bank guidance, elevated inflation, and a significant tightening in financial conditions.
Chart 1 shows the status of regional market interest rate forecasts for 2022 and 2023 as well as the respective central bank forecasts. It can be seen that except for Japan, all other regions have witnessed significant uplifts to interest rate curves over the last three months.
Chart 1: Regional consensus and central bank 2022 and 2023 interest rate forecasts
Both the Fed dot plots and market interest forecasts have risen by 100 basis points. While the Fed forecasts point to a continued gradual increase in rates, peaking at 4.6% by the end of 2023, the market is predicting a gradual decline in rates over the course of the second half of next year.
Chart 2: US market consensus and Fed dot plot interest curves
Our Financial Conditions Indicator (FCI) is designed to reflect the impact on market risk appetite through the combined impact of related financial components. Since mid-August, the US FCI has increased and is in restrictive territory (a key driver of risk aversion). Some of the key elements pushing the FCI higher have been the rise in the USD (REER), interest rate forecasts, government and corporate bond yields and a contraction in real M2 money supply growth.
Chart 3: US financial conditions being driven higher on many fronts
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