What next after SVB collapse? 30% chance of interest rate cuts by the summer

That escalated quickly. 

Silicon Valley Bank (Nasdaq: SIVB) is no more, the biggest banking casualty since Lehman Brothers shocked the world in 2008. In came the US administration, pulling out emergency stops to stave off the crisis – in the short term, at least.

As Joe Biden said, “that’s how capitalism works”. 

But the impact will be far-reaching. The market has realised this already. Looking at expectations for interest rates, the change is staggering. 

Sunday evening, July Fed Fund futures dropped from 5.63% to 5.15%. That translates to a near-50 bps fall in forecasts for the Fed’s interest rate hiking policy in the blink of an eye. 

Looking at Fed futures-implied probabilities, the below charts show how significantly the outlook for the next Fed meeting has flipped. 

Within a few days, we have gone from a 70% chance of a 50 bps hike to 0%, while the baseline expectation is now no hike at all, at a 72% probability from 0% last week. 

But why? Well, because things are breaking, that is why. We have known the whole time that the Fed’s big goal over the last year has been to hike rates enough so that inflation is reined in, yet not too much so that the economy is hamstrung and a dirty recession is triggered. 

Sunday brought a wobble in the banking system, with the market moving to the expectation that the Fed simply can’t avoid pivoting off its previously tight policy. 

What does this mean for risk assets?

Of course, risk assets only need a sniff of the word “pivot” and they pack their bags to head north on charts across the sphere. Bitcoin was the headliner yesterday, leading crypto coins up as it retook $24,000, back to its level of two weeks ago, after dipping below $20,000 amid the crisis on the weekend. 

As has been the case all year, it is a case of bad news is good news. Why should stocks and crypto surge when banks nearly collapse? Because a near disaster means a return sooner to the promised land that is low interest rates, that is why. 

It is a funny world we live in. 

Are interest rate hikes over?

But what about the big question: are hikes completely over? We have looked at the probability of hikes at next week’s Fed meeting, but what about forecasts around the terminal rate? Is the cycle of rates completely over?

The best way to look at this is to do exactly what we did above for March futures, except for July. The below chart shows in orange the probabilities today, compared to the black bars showing last week’s probabilities. As I said, things have escalated rather quickly. 

The chart shows only a 1.6% chance of a higher rate in July. That is incredible when last week’s forecast had this number at 100% – that is right, futures implied literally 0% chance that rates would not be higher by at least 50 bps. 

There is even a 30% chance of lower rates in July. Analysts from Goldman Sachs also came out Sunday evening saying they were on board with this expectation. 

It’s beginning to make sense why Bitcoin has run up past $24,000, right? 

Of course, inflation is still roaring out there, even if it has come down past its peak. The latest CPI reading is out this afternoon and does have the chance to shake things up if it comes in hot. 

But that would be a surprise. The market has shifted from fearing inflation to fearing a recession since the turn of the year, and all signs do point towards inflation coming down. And now, with the banking wobble thanks to SVB succumbing to the chokehold of high interest rates, the market thinks the Fed has no choice but to get back to lower interest rate policy. 

Hey Jerome, you remember where you put the money printer?