As the days go by, the intense urgency of the banking crisis has faded and conflicting narratives have emerged. Some see the next bull market emerging in equities and crypto, while others are increasingly alarmed by what they see as a dislocation that will be corrected. US and EU inflation numbers show a slight cooling in inflationary pressure, but they remain uncomfortably high at the same time that growth concerns have come to the forefront, with different parties having significantly different expectations. The question of who is right remains very much in the air, and with this much uncertainty, the risk of a policy misstep remains notable, and it is quite possible there is just no correct answer left for many.
With no other banks looking to be on the brink of failure and regulators having shown a willingness to step in at the first sign of trouble, contagion fears are much reduced. Fed balance sheets shrunk in the week ending March 28. Deutsche Bank, seen to be the next GSIB at risk after Credit Suisse, looks to be stable for the moment.
The ballooning of Deutsche Bank’s credit default swap spreads has been attributed to a relatively small trade in an illiquid market. In the aftermath of Credit Suisse’s collapse, the fear that this was a sign that market insiders knew something everyone else did not along with Deutsche Bank’s own poor reputation produced a significant selloff on Deutsche Bank and across broader markets. Even taken at face value, the market nervousness reflected is itself a cause of concern, and could lead to more instances of shoot first ask questions later. In the longer term expect credit to remain exceptionally tight.
With European and American central banks stepping in to support their financial institutions, some have seen their actions as effectively quantitative easing and a sign of monetary loosening to come for the broader economy. This is a gross mischaracterization. The Feb balance sheets have expanded as regional banks are forced to head to the lender of last resort and borrow at overnight rates far above the norm. Similarly, the liquidity support provided by the Swiss to UBS and Credit Suisse is far from free. Most would agree that giving out what is effectively a payday loan would not exactly count as loose monetary policy.
Concurrently, traditional monetary policy indicators such as money supply measures have collapsed in a way unseen since the 1930s’ Great Depression. Meanwhile, the velocity of money remains low by historical standards and is likely to have seen a further contraction since the last reading was taken.
All of this combines to suggest that the current policy support is a way to spread out the pain and prevent acute liquidity troubles from unduly damaging the financial sector. With the health of the financial sector having visibly deteriorated, the real economy is likely to see tighter conditions even if rate cuts arrive soon.
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