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20/3/2023 - What the Fed can do next to protect the US banking system
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God willing, We are ahead of next for awaited meeting of the FOMC member this
week, after increasing worries about the banking sector efficiency in US, after
the vcbís collapse, assuming deposits of Signature Bridge Bank by a subsidiary
of New York Community Bancorporation to prop it up and the First Republic rescue
plan worth $30b by a group of 11 giant banks could not hold S&P back from
downgrading it deeper into junk territory to ďB-plusĒ from ďA-minusĒ saying that
it is still in sack of liquidity.
The worry was not about a failure of a bank, 2 or more, but the reason why we see that fallout. As vcbís assets structure of holding a great ample of low yielding UST is not something special for it, but itís widely in use of the investment vehicle of major banks in US and even out of it.
While they are watching rising of UST yields in the secondary money markets on the Fedís current adopted tightening policy to contain inflation with no action, making their profitability lagged behind the yield curve of their holding of UST and in exposure to fallout short of liquidity can drive them to the money market to book losses.
While the recent inflation data from US were suggesting moving of Fed fund rate up by 50 basis point more, as what Fedís Chief Jerome Powell has been figured out during his recent testimony to the senate banking affairs committee earlier this month, before the crisis of svb, expecting holding rates high for longer time to contain the inflation upside risks in US.
But now after these looming financial risks, the odds of watching 50 basis hiking this week diminished and the probability of holding rates unchanged increased but the most expected is still tightening by 0.25% for curbing inflation.
Surely, the new quarterly announced projections of the interest rate by FOMCís members will be closely watched to know their will and also their evaluation of the inflation, the growth and the unemployment rate next.
Until now, The Fed is looking aware of the problem and eager to work on it with the treasury and other counterparts opening swaps window with other 5 major central banks to infuse USD liquidity.
But what can they do next;
- The FOMC can lower the interest rate to lower the pressure on the banking sector generally and to reduce the probability of watching further fallout. But that is hard to bring back the trust in the financial market and the banking sector as no sign of inflation setting back or even looming recession risks yet. While the Fed fund rate is now close to 5%, after tsunami of hiking by the Fed hit the banking sector which lived for relatively long period of holding rates it near zero.
- The Fed can show also trust in the banking the sector and economic performance and choose to tighten by another 0.25% to fight inflation and this is also respectful choice as it shows also that it is well-contained problem.
- The Fed can choose to provide relatively low yielding loans for the banking sector grunted by the banks holding of US Treasuries as a Collateral on their maturities to smooth the pressure on them. This action can support them directly to face the crisis and that is my view and it can be taken with other easing steps, if the pressure on the Fed accumulates and it can be also with the Fedís current adopted policy to fight inflation.
Global Market Strategist
Walid Salah El din
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