Treasury bonds surged, pushing key two-year yields to their lowest level this year, as investors bet the collapse of three US lenders will compel policymakers to halt interest-rate increases.
Swaps now show a less than one-in-two chance that the Federal Reserve will implement another quarter-point hike this cycle. Yields on two-year Treasury notes — the most sensitive to changes in policy — fell as much as 60 basis points to less than 3.99%, the lowest since October.
The three-month London interbank offered rate for dollars, a key benchmark, dropped by 27 basis points, the most since March 2020. The dollar also declined.
Money markets are betting the Federal Reserve is probably done with hiking this cycle. Traders are now pricing a less than one-in two chance the Fed will hike by another quarter point at all this cycle, with cuts after that.
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, although the immediate fragility of the financial system may well overshadow matters.
“Mr Market always want to search out the weak link,” said Jack McIntyre, a portfolio manager at Brandywine. “The data is not as important as what is going on with the financial system. Just have to let the dust settle and see how CPI plays out.”
Treasuries have been whipsawed in recent sessions by the evolving rate-hike outlook. Two-year US yields slid in the past few days 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.
That view of Powell’s 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, although it still sees tightening this year.
“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, with German and Japanese yields plunging.
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 and Michael MacKenzie.)
