Market Skepticism and Banking Turmoil: Can Central Banks Handle the Heat Alone?
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👤AXA
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Market reactions to the ongoing banking turmoil resulted in a significant downward revision of expectations for the policy rate of both the Federal Reserve and the European Central Bank (ECB). The market expressed its skepticism regarding the central banks' ability to address financial stability issues solely through liquidity measures without altering their policy stance. While prudence is warranted in the pace of tightening, the ECB should consider resorting to 25bps hikes instead of the recent increments of 50bps.
Central banks are likely to balance the signals that inflation is taking too much time to decelerate with the possibility that banking stress triggers a sharp deterioration in economic activity, thereby dampening inflationary pressure. The US is witnessing deposit migration from smaller to larger banks, which has macroeconomic implications. Small banks have a higher loan-to-deposit ratio than larger ones and play a critical role in real estate, which is already under significant pressure. Higher banks' funding costs due to a higher risk premium will be another transmission channel.
In aggregate terms, small banks in the US have comparatively fewer interest-rate-sensitive securities on their balance sheets than their larger counterparts. The solution found for Credit Suisse with UBS, with decisive support from the Swiss government and central bank, involves writing down the AT1s, but bonds higher up the seniority ladder appear to be protected. Confidence always plays a significant role in banking crises, and public authorities are determined to act decisively and promptly to address the current US predicament.
By
👤AXA
