- Silicon Valley Bank and Signature Bank have been shut down by regulators over the past few days.
- Market participants are beginning to anticipate a less hawkish Fed in response.
- But the founder of Sevens Report, Tom Essaye, sees the tightening policy and their rate hikes sticking.
Following the collapse of Silicon Valley Bank and Signature Bank in recent days, some market participants are expecting the Federal Reserve to back off its hawkish stance.
Goldman Sachs US chief economist Jan Hatzius said Sunday night he expects the Fed will not hike rates at its next meeting before resuming it later in the spring. Barclays economists also said on Monday they expect a pause at the March meeting.
Nomura economists went even further, saying they expect the Fed to cut rates by 25 basis points at its March meeting. Two-year Treasury yields, which normally trade at levels close to the fed funds rate, also reflect a dovish narrative, which has fallen from 5% to 4% since March 8 on expectations of a more neutral or even more dovish Fed.
But Tom Essaye, founder of market research firm Sevens Report, disagrees with the notion that the Fed will start to retreat. Essaye’s clients include UBS, Morgan Stanley, JPMorgan and Charles Schwab.
The Fed’s next moves are relevant to recent events, as higher interest rates contributed to the Silicon Valley bank’s demise. The company had a majority of its deposits – almost 100 billion. The events of the past few days have now added another risk that the Fed must take into account as it considers further rate hikes.
In a note Monday, he said the Fed will view the bank’s collapse as an isolated risk.
“The market is aggressively pricing in that this whole saga will make the Fed less hawkish as fed funds futures show a 25% chance of no rate hike in March and a terminal Fed funds rate of just 4.625% (which pricing in this increase in March will be the last). I disagree with that assessment,” Essaye said.
“Bank stress is a risk, but inflation is still at 6% and the creation of the BTFP will expand the Fed’s balance sheet at a time when it is trying to shrink it (the Fed is actively engaged in quantitative tightening) said Essaye on the Bank Term Funding Program.
He continued, “Unless this regional banking stress metastasizes into a full-blown national banking crisis (which is highly unlikely), I don’t think the Fed will stop raising rates anytime soon, and if it does at all, it could eventually lead to the… Interest rates will stimulate the economy and cause the Fed to rise more sharply in the longer term.”
Some on Wall Street agree with essays and believe the Fed will remain hawkish. For example, Jeffrey Gundlach, the CEO of DoubleLine Capital, told CNBC on Monday that the central bank will hike rates by 25 basis points at its next meeting.
How to position your portfolio
Essaye said the bank closures wouldn’t have a huge impact on stocks over the long term, but that the S&P 500 could see a 10% sell-off in the near term.
He advised long-term investors to stay invested in safer areas of the market.
“I don’t think last week’s volatility is a bearish game changer,” Essaye said. “Yes, it will increase volatility.” Yes, we could see a 10% drop in the coming weeks. The long-term outlook is not significantly more negative now than it was two weeks ago and for those with a longer time horizon we still recommend holding core equities and bonds with an emphasis on defensive sectors (utilities/staples/healthcare) with low volatility ETFs (SPLV) and Value, as that should weather the continued volatility better than higher beta portions of the market.”
Investors looking for exposure to the areas of the market listed above could consider funds such as the Vanguard Utilities ETF (VPU); the Consumer Staples Select Sector SPDR Fund (XLP); the iShares US Healthcare ETF (IYH); and the Vanguard Value ETF (VTV).
