Nomura predicts Fed rate cut on financial stability concerns

Sam Stovall, Chief Investment Strategist at CFRA believes that the Federal Reserve will continue to hike rates by 25 bps through the second quarter of the year, before pausing to maintain the prescribed level.

His comments follow Chairman Powell’s hawkish statements last week in response to stubborn inflation.

The FOMC chairman indicated that the institution would consider resuming 50 bps hikes as early as the March meeting.

However, within 3 days of this announcement, the iconic Silicon Valley Bank (NASDAQ: SIVB), financier to the tech sector and specialist VCs, was shuttered as panic ensued around a full-fledged bank run.

The collapse came following a meteoric tripling of the bank’s deposits between 2019 and 2021, owing to ultra-loose monetary policy and pandemic-era fiscal injections.

In turn, the now-defunct SVB deposited the bulk of these inflows in the theoretically secure 10-year paper.

Following the sharp upsurge in yields since 2022, this strategy came undone, resulting in a 60% drop in share value on Thursday, and then again in Friday’s pre-market action.

Source: US FRED Database

On Sunday, Signature Bank went underwater as well, indicating that carnage in the regional US banking system looks set to continue.

Joint statements made by the Fed, the Treasury and the Federal Deposit Insurance Corporation (FDIC) seem to have done little to soothe investor anxiety, with regional banking stocks continuing to cede ground in trading on 13th March.

Source: WSJ

Moreover, the tech sector has been especially vulnerable to layoffs.

Robert Kientz, Founder of GoldSilverPros, noted,

The U.S. has had twice as many losses in technology in the last quarter than the rest of the world combined.

This could be indicative of further troubles in the already overvalued tech sector and would place the West coast banks firmly in the crosshairs.

Despite the rising fear of runs on regional banking institutions, Stovall expects that monetary policymakers have the space and resolve to continue to tighten through Q2.

He notes that small-cap stocks could be particularly hard hit as conditions have already tightened significantly following the tumult in the banking system.

The S&P Small Cap 600 Index lost 6.9% of its market cap in the past 5 trading sessions.

Contagion-fearing regional banks will likely be reluctant to extend lines to this sector given its weaker balance sheets, lower access to capital and limited scope of operations.

Pivot outlook

Today’s core inflation print came in at an elevated 0.5% driving expectations of a quarter-point higher from half to 82.7%, according to CME FedWatch Tool.

Yet, the past few days have exposed the financial system’s fragilities, particularly concerning the sheer volume of unrealized losses.

Source: FDIC

At present, policymakers are showing limited appetite for the fight, having announced a $25 bn facility to backstop the Fed’s new policy tool, the Bank Term Funding Program (BTFP), far from sufficient to cover the huge hole of hundreds of billions of dollars in unrealized losses building up in the system.

This poses a major challenge for banks and in turn depositors. If confidence continues to erode and results in accelerated withdrawals, raising adequate capital will be virtually impossible.

Thus, interest rate pressures and a liquidity crunch could quickly become financially destabilizing, which contrary to the CME data may drive the Fed to pause sooner rather than later.

The coming week will be a nervy one for policymakers and markets alike.

If the financial system churns out more failures in the near term, as is looking very possible, the Fed will likely be forced to pause in the next meeting itself.

Analysts at Nomura take an even more extreme position and expect the Fed to announce a cut by 25 bps in next Wednesday’s press conference.

In addition, they expect the Fed to start unloading bonds back into the market while China and Japan are already off-loading US treasuries as well.

Peter Schiff, Chief Economist and Global Strategist at Euro-Pacific Capital stated last month that disinflationary trends (which have continued to stay above 6%) could be violently reversed if the Fed’s hand were to be forced into a pivot. This article discusses his take.

The strongest impulse to tighten into suddenly and severely tightened conditions may be a result of fearing the sort of resurgent inflation that Schiff has already warned of.