Government bonds across the world staged a historic rally in a rush for havens as investors bet the collapse of three US lenders will compel policymakers to slow the pace of monetary tightening.
(Bloomberg) — Government bonds across the world staged a historic rally in a rush for havens as investors bet the collapse of three US lenders will compel policymakers to slow the pace of monetary tightening.
Yields on two-year Treasury notes — the most sensitive to changes in policy — headed for the biggest two-day slide since 1987, while equivalent German rates were on course for a record drop Monday. A gauge of the dollar lost as much as 1% as the yen and Swiss franc rallied.
“Both the speed and end point of the Fed hiking cycle should come down,” wrote George Saravelos, global head of foreign exchange research at Deutsche Bank AG. “The bar for the Fed to reaccelerate tightening is significantly higher.”
Money markets briefly bet the Federal Reserve was done with hiking this cycle. Traders are now pricing just a single quarter-point rate increase by June, compared with expectations for as much as 110 basis points as recently as Thursday. The picture also shifted in Europe, with a peak for the European Central Bank seen below 3.50%, versus 4.20% last week.
It’s the latest abrupt change in the stop-start trajectory in recent months for further interest-rate hikes, as traders factor in the risk of banking contagion alongside the prospects for growth and prices. Some analysts warn the outlook may shift again if US inflation data due Tuesday beats expectations.
Treasuries have been whipsawed in recent sessions by the evolving rate-hike outlook. Two-year US yields slid as much as 43 basis points to hit 4.15% Monday, after jumping above 5% last week when Fed Chair Jerome Powell said the central bank was likely to lift interest rates higher and potentially faster than previously anticipated with inflation persisting.
Fed Half-Point Hike Looks Less Likely as Financial Risks Flare
That view may change after the failure of three lenders in recent days, including Silicon Valley Bank, highlighted the fallout from higher interest rates. Goldman Sachs Group Inc. has scrapped its call for a rate hike at next week’s Fed meeting.
“We have to add one more factor to Fed policymakers’ thinking, which is the burden on the financial system,” said Kenta Inoue, a senior bond strategist at Mitsubishi UFJ Morgan Stanley Securities Co. in Tokyo. “It’s become quite difficult for them to opt for a 50-basis point hike. SVB’s collapse has increased the probability that the end of the Fed’s rate hikes isn’t too far off now.”
The impact of the banks’ collapse also triggered shock waves around the world. German two-year yields fell as much as 51 basis points, surpassing declines seen during the global financial crisis in 2008. Japan’s 10-year yield slid to 0.315%, the lowest since the nation’s central bank unexpectedly doubled a yield cap on Dec. 20.
Traders are now watching for further responses from policymakers. The Fed set up a new emergency facility to let banks pledge a range of high-quality assets for cash over a term of one year, in the wake of SVB’s collapse. Regulators also pledged to fully protect even uninsured depositors at the lender.
SVB’s descent into FDIC receivership — the second-largest US bank failure in history behind Washington Mutual in 2008 — came suddenly on Friday, after a couple of days where its long-established customer base of tech startups yanked deposits.
Still, concerns are growing that the failure of the three banks may just be the tip of the iceberg.
“The risks are clearly there” that SVB’s collapse may be the canary in the coal mine, TD Securities strategists led by Priya Misra wrote in a research note on Sunday. “The macro fallout of SVB on the tech sector and bank lending standards as a whole should weigh on risk sentiment and longer term growth expectations.”
–With assistance from Liau Y-Sing.
(Updates throughout.)
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