The market has overstated the influence of the Silicon Valley Bank (SVB) collapse on future interest rate hikes, according to GSFM investment strategist Stephen Miller.
“While the SVB collapse may temper at the margin the Fed’s disposition to increase the policy rate, I do not believe that any adjustment to any pre-existing Fed plan will be of the order of magnitude reflected in bond market pricing,” he claimed in a recent note.
Mr Miller argued that the bond market has overestimated the extent to which activity and employment would decline, and the pace at which inflation would fall.
He suggested that there are two ways to view the SVB collapse.
The first points to it being an “isolated incident” that reflects the “idiosyncratic nature” of SVB’s depositor base.
The second implies that SVB is akin to a “Lehman Moment” and that its collapse is indicative of more systemic concerns.
Mr Miller believes in the first scenario.
“I’m not suggesting that it is prudent for markets (or, indeed the Fed) to regard the collapse with indifference. But the collapse did in the main reflect the idiosyncratic nature of SVB’s depositor base,” he said.
“Certainly, and appropriately, it has focused attention on mainly regional banks that have an idiosyncratic depositor base (or other idiosyncratic features that attach to their business models), that leave them open to particular risk events. But it is a long way from a ‘Lehman Moment’.”
Prior to the SVB collapse, markets in the US were contemplating a peak policy rate of around 6 per cent, which was expected to remain in place until sometime next year.
However, they are now pricing a peak rate in May this year of close to 5 per cent, and reductions of approximately 70 basis points spread across the rest of the year.
Mr Miller doesn’t share this sentiment. He assessed that the latest data points to the Fed having made “at best” only “grudging progress” in the fight against inflation.
As such, he predicted that the Fed will deliver a 25 basis point (bp) increase in March, followed by at least 50 bps of further tightening later in 2023.
SVB impact on RBA
On the local outlook, Mr Miller said that Reserve Bank (RBA) governor Philip Lowe had “sensibly” signalled a more flexible approach to rate increases, with the central bank recently pledging to carefully assess key economic data ahead of its April board meeting.
“While the Australian financial system is at the outer edge of the ripples from the SVB collapse, to the extent that the SVB collapse tempers the Fed’s disposition to raise the policy rate then that would also likely extend to the RBA,” he warned.
“That is regardless of the way the data falls because of the likely currency implications of a more moderate Fed.”
Given the view that the market has overstated the influence of the SVB collapse on the Fed’s path for policy rate increases, Mr Miller judged that the RBA is unlikely to pause.
The latest NAB Monthly Business Survey, he noted, also doesn’t support a pause given strong price, labour cost, activity and employment data.
Moreover, Mr Miller judged, Australia has yet to experience a turning point in its inflation data, one mirroring that seen in the US, Canada, and New Zealand.
“In the past, the governor has mentioned that the path between the vanquishing of inflation and avoiding a recession, or at least a sharp growth slowdown, is a narrow one,” Mr Miller said.
“My view is that path has got narrower through 2022 because of a seeming reluctance on the part of the RBA to act aggressively in confronting inflation.”
In the absence of a “deterioration” in the health of the international financial system on a scale that begins to resemble the Lehman episode, he suggested that it would take an unexpected downshift in the monthly CPI indicator due out on 28 March to justify a pause.
“Were the RBA to avail itself of the opportunity to pause without the forgoing conditions in place, the governor’s path could get even narrower,” Mr Miller concluded.
