Though the immediate pressure on Wall Street is imminent and that cannot be done away with, do you see the banking crisis being handled in a better way?
The US definitely is handling it better because we saw the resolution that happened over the weekend in terms of guaranteeing deposits.
Because it was not a bailout, nobody should be surprised that Silicon Valley Bank has filed for Chapter 11 because clearly they do not have enough equity to continue. So, I think that is a resolution which was expected and it has happened very quickly.
This is what we are not seeing in Europe and at least in the case of Switzerland. I guess it is down to the size of Credit Suisse. They have a much bigger asset base of 54000 employees. So I guess it gets a bit more political. I have heard news that both Credit Suisse and UBS are resisting any forced merger so it is not as straightforward.
But ultimately, if push comes to shove and they have to do a resolution because I do not have full information but deposit in my guess will continue to leave Credit Suisse.
And at some point very quickly it will become that bank and as a unit in terms of the equity capital it is not viable and then the regulators will have to step in. Now that could be the way it goes out.
Now, bear in mind that the Swiss National Bank has a lot of assets on their book. I mean, they hold $139 billion of US equity, so they do have enough firepower to resolve this. But this is Europe and Switzerland and it might take longer. But in the US, I think they have handled as well as they could and it was done in a very swift manner.Bond markets are rallying too and it is as has been expected. But do you expect any kind of consolidation that is going to shake up the markets? Is that likely to happen? You also said that politics will come into play and perhaps in times like this that too should be factored in but in case that kind of huge consolidation happens, how are the markets going to treat it?
You will see smaller banks close down or an asset move to a bigger bank. That is definitely going to happen in the US because if the bigger banks are paying higher insurance costs with the FDIC, they do not want the bad banks or smaller banks to continue. Further, we will have to watch what the Fed does next week on the rate front.
When the rates are cut, then a lot of these investments will look much better than they are at this stage because you bought something at 1.65% yield and now it is yielding 5%. And if the depositors do not deposit money in the bank and go for money market instruments or other things then that also puts pressure on a lot of these banking operations.
So as I have been saying for a long time that rates have gone too far too high, it is not sustainable, and everyone will look at what the Fed has to do.
And if the Fed raises rates next week, which it could, given where the inflation number is then I think this is not going to go away and it is going to force Fed’s hand eventually and you may see that.
But for now, the fact that they have said that the banks in the US can offer the security they hold on the book to the central bank at par or to FDIC then that is going to resolve the issue temporarily and in the medium term. But the longer term issue is about yield, it is about interest rate and those interest rates have to come down.
What do you expect the FOMC to do next? Also, where do you see the terminal rates and how soon do you think we will arrive there?
Last week on Monday, the market was expecting a 50 basis point rate hike. There was no expectation of a rate cut this year. Right now, as you see, the futures have priced in a 100 bps rate cut. The two year yield has gone from 5% to 3.7% and now back to 4%. So I do not think the day to day movement of the market can be relied upon, to see where the yields are going to be. So if you take a medium term approach then the federal fund rate in my opinion just cannot be over 3-3.25%. I just do not see how it is going to be at more than 3.5% by the end of the year, because few other things are going to happen.
When smaller banks close down, the credit expansion that happens to businesses is going to come under pressure that may lead to worse GDP numbers. There will be no basis for the Fed to keep rates high. We might be entering into a disinflation scenario by the end of this year, so it does not have to keep the rates at 5-5.5%. Hence, I see the Fed fund rate ending the year in the US at around 3-3.25%. Therefore, I anticipate an at least 200 bps rate cut by the end of the year.
