No surprises. Last week, I laid the groundwork for this week, which would surely be marked by Central Bank action. Wednesday the Fed, Thursday the ECB. Despite some weekend turbulence in the (guess what) banking sector, last week´s market predictions materialized. But while, in the Fed case, a 25-basis point increase was completely baked in, in the ECB there was not that big of a consensus. Nonetheless, some data coming before Christine Lagarde and her governing council’s decision made also a 0.25% hike the most expected and reasonable, instead of a half-a-percentage-point commitment.
As is now the ritual, we cannot go one week without mentioning US banks. During the weekend, we had the 4th bank failure since early March (not counting our very close Credit Suisse, whose failure is of fundamentally another nature, i.e.: not mainly driven by interest-rate risk). To add up to SVB, Signature Bank, and Silvergate, First Republic couldn’t stand the pressure, and became the 2nd biggest in US history to fail under the Federal Deposit Insurance Corporation (FDIC) watch.
Despite being a big and potentially impactful event, it got resolved pretty quickly. The big brother JP Morgan came to the rescue. But with the conditions that held, I would also come to the rescue at high speed. The FDIC seized the bank, and JPM committed to pay $10.6 billion to the Resolution Authority, via a loss-sharing agreement. To make the story short, the assets (mainly loans) of First Republic go into JPM’s book, and any loss that eventually comes out of these loans will be shared with the FDIC. The upside, however, goes entirely to JP Morgan.
Last week, we were widely expecting a 25bp decision coming out of Jerome Powell. First Republic’s failure didn’t change this at all. If anything, it added some strength to the also expected possibility that this may be the very last rate hike in this sequence.
The Fed’s decision and guidance were at par with the expectations. Not only did the rate increase get the Fed Funds Rate to the range of 5-5.25%, but also the wording on the statement was indicative of a change on the path: they are stopping. The most aggressive tightening campaign since the 1980s is about to terminate.
From the March meeting statement, the reference to the fact that the Committee “anticipates that some additional policy firming may be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2 percent over time” was dropped and replaced by “the Committee will closely monitor incoming information and assess the implications for monetary policy” in this Wednesday’s statement. I know it is kind of subjective to try to be reading in between the lines, and that they don’t clearly say they will stop. The truth is that they cannot make it that clear, because their number 1 enemy – inflation – is not yet beaten.
Exactly due to this, there is still some divergence between the Federal Reserve guidance and market pricing. How long will the pause last? The market is not buying at all the idea that rates will stay at 5.25% for a lengthy period, and is expecting interest rate cuts sooner than what Powell wants to see priced in. And why doesn’t he want it? It is a matter of both 1) credibility of the central banks and 2) the fact that it’s through the market pricing that the Fed affects financial conditions: if they’re misaligned, the central bank’s efforts will not be as effective.
In this case, as stated before, the prognostics were not unanimous. Despite that, the ECB ended up delivering a move that barely surprised anyone and showed as the most sensible one.
Remember last week’s article? The sluggish growth that came out of the eurozone GDP’s report made more people move to expect a 0.25% hike and hence made fewer people stay on the 50 bips team. To add to this, fresh data pointed to both a) core inflation cooling last month (even though the core number is not the target, is a big point of focus) and b) credit conditions, as shown in the euro area bank lending survey, tightening in the continent.
Summing all up, 25. 25 was the way to go. And so did Christine Lagarde, following her cross-Atlantic peer. The main refinancing rate moved up to 3.75%, and the deposit facility rate went from 3% to 3.25%. Further, the ECB expects to stop the reinvestments of the Asset Purchase Program (APP) and the respective reinvestments in July.
The difference to the Fed was in the forward guidance. Lagarde couldn’t have been clearer. In the press conference following the decision, she stated that they knew they have “more ground to cover on the basis of the baseline and the data” in order to get inflation back to the 2% level. The punchline was even more aggressive: “We are not pausing”.
Is this the end?
Well, for the ECB it surely isn’t the end of the tightening cycle, unless something ultra-extraordinary happens. For the Fed, it most likely is, unless the big (already) old opponent comes again stronger than it should. But there is one thing that’s really coming about to its end: the Week at the Close. The academic year closes with this week of Central Banking, which has been the main story for the last couple of years.
Things will certainly evolve, and when the Week at the Close comes back, the landscape will be completely different. Either for bad or for good, Tra i Leoni will be here to cover it. So, it’s not a definite goodbye, it’s a “see you back in September.”