The recent collapse of three US banks and the downfall of Swiss giant Credit Suisse has largely been attributed to poor liquidity management exposed by aggressive monetary policy tightening from the world’s central banks.
This has stoked fears of widespread frailties in the capital management practices of banking institutions around the world.
But according to Andrew Canobi — director of the Franklin Templeton fixed income team in Melbourne and bond portfolio manager — a systemic banking crisis is “highly unlikely”.
Mr Canobi said recent volatility in the sector exposed “idiosyncratic weaknesses”, which have focused market attention on liquidity management.
However, he claims liquidity pressures can be “solved with the flick of a switch”.
For Mr Canobi, the “real culprit” is the “constriction of credit supply” induced by the central bank “assault on inflation”.
“The supply of credit supports growth and drives inflation. Just as the excess creation of money through the pandemic caused inflation to surge, its rapid destruction as central banks shrink the money supply is highly disinflationary,” he observed.
“In a highly financialised world fuelled by liquidity and availability of credit, sooner or later, things start to break when central banks withdraw that credit and liquidity as rapidly as they have.
“…The warning signs have been brewing for several months that monetary policy has been biting and hard choking off the supply of money. This is the pointy end of the hiking process.”
He went on to argue the demise of Silicon Valley Bank may have originated from a “dramatic shrinkage” of capital flow to equity, start-up, and tech sectors — the core customer base of the failed California-based bank.
“As credit has been drained from the system and liquidity becomes scarce, funding markets for start-up ventures has dried up,” Mr Canobi added.
“What do you do then? You draw on your liquid bank deposits.
“So, whilst we might finger point at idiosyncratic blow-ups, the fact is, central banks have squeezed funding markets like the proverbial lemon making the cost and availability of credit that much more challenging.”
The world’s largest central banks have continued to pursue a monetary policy tightening strategy, with the US Federal Reserve, the European Central Bank, and the Bank of England recently actioning 25 bps hikes.
The Federal Reserve has hiked its federal funds rate by a cumulative 4.5 per cent since March 2022.
According to Mr Canobi, central banks are set to hit the brakes in the near term and end their war on inflation.
“Many have said central banks can’t stop raising rates even amidst these ructions because of inflation,” he said.
“If credit and liquidity tightens as it has, inflation’s grave is dug. It may not have been filled in, but it’s over and just a matter of time.
“Central banks will be highly sensitive to signs that the financial system is quaking, and the flow of credit is stalling. We expect the bar to ignore market events and keep tightening in the near term is high.”
However, markets are split, with many observers pricing in further hikes over the months ahead.
Global asset manager BlackRock has said despite projections of a recession, the Fed would not cease hiking.
“[The Fed] doesn’t see inflation falling back near its target until 2025. Even so, we think the Fed is underestimating how stubborn inflation is proving due to a tight labour market.
“Inflation could remain above its target for even longer than that if the recession is as mild as the Fed projects.”
In Australia, the Reserve Bank has actioned 10 hikes to the cash rate since May 2022, totalling 3.5 per cent.
But following the RBA’s March meeting, governor Philip Lowe conceded the central bank was “closer to a pause”.
“We’ve done a lot in a short period of time and at some point, it’s going to be appropriate to sit still and assess the collective effects of that,” he told the AFR Business Summit on 8 March.
Lowe said the board would carefully assess key economic data to be released ahead of the next board meeting, including monthly employment, inflation, retail spending, and business indicators.
“If collectively, they suggest that the right thing is to pause, then we’ll do that. But if they suggest that we need to keep going, then we will do that,” he added.
“So, we’ve got a completely open mind about what happens at the next board meeting.”
