Yahoo Finance OCBC’s Vasu Menon expects US Fed to raise rates by 25 bps; ‘banking crisis’ does not spell ‘gloom and doom’
"In a nutshell – be nimble, stay defensive, focus on quality, and invest carefully and gradually with a mid to long-term view."
Vasu Menon, the executive director of investment strategy at Oversea-Chinese Banking Corporation (OCBC) is expecting the US Federal Reserve (US Fed) to raise rates by 25 basis points (bps) on March 22 as inflation remains a problem.
But like the European Central Bank (ECB) on March 16, the Fed could “offer reassurance to the markets that it will provide support, if necessary, amid the turmoil in the banking sector”, says Menon in his note on March 21.
He adds: “The Fed is clearly between a rock and a hard place as it tries to battle inflation while trying at the same time to make sure that it doesn’t exacerbate the woes in the banking sector brought on by its huge rate hikes last year - the largest calendar-year hike in more than four decades.”
The Fed’s dot plot after its policy meeting will also be closely watched to see if policy makers change their view about the outlook for interest rates. Market watchers will also be assessing if the Fed’s hiking cycle is close to its peak, says Menon.
“The turbulence in the banking sector has cast a pall on the economy and this may restrain the hands of the Fed and prevent it from doing anything too drastic going forward – which will be welcomed by investors,” he writes.
Should the Fed adopt a more dovish tone at its upcoming policy meeting on March 22, investors could find some relief. However, Menon notes that it may be premature to turn positive on the markets, even with a more dovish Fed.
“The risk of more negative headlines about the banking sector will continue to keep investors on edge and markets volatile,” he says, adding that the significant shift away from the decade of low- interest rates has exposed weaknesses in the financial system. Investors will also be worried that more surprises could be in store.
In his note, Menon says the bond losses suffered by the “weakest links” in the banking sector remain a headwind and may continue to cast a shadow on the markets as they gradually surface.
To this end, the problems for the small and mid-sized US banks may not be over and rating agencies may continue to downgrade their ratings. Such downgrades will hurt the profitability of these banks and can shake investor and depositor confidence in them, he adds.
Like the rest of the analysts, Menon sees that the recent banking crises in the US and Europe do not spell “gloom and doom” and is likely to cause a global financial crisis (GFC) like the one in 2008.
“For one, during the 2008 crisis, assets like mortgage-backed securities were hard to value, making it difficult for banks to assess their worth. However, this time around, US Treasuries and bonds, which are the key assets causing problems, are much easier to value and sell,” says Menon.
“The current crisis is more of a confidence crisis than a solvency crisis, although the former can cause liquidity woes and cause balance sheet problems as we saw in the case of Silicon Valley Bank and Credit Suisse (CS). However, government regulators are aware of this, and their early action should prevent much bigger problems and a 2008-style crisis,” he adds.
Furthermore, the GFC made central banks, regulators and governments realise that they must act quickly to stem a big fallout so that they’re able to avoid a repeat of what happened in 2008.
On the US banking “mini-crisis”, Menon adds that the big banks in the country are well-capitalised and face regular stress tests from the US Fed. “It’s the smaller regional banks that are a problem but it’s a smaller problem which the Fed and US regulators can manage with little international ramifications unlike the collapse of Lehman in 2008.”
In Europe as well, the large banks are well regulated and capitalised, and the ECB has pledged support if needed. The recent UBS takeover of Credit Suisse which was facilitated by the Swiss central bank and the country’s regulators shows the determination and boldness amongst the authorities to stem the confidence crisis,” he adds.
In conclusion, Menon sees that the markets will take time to regain their footing given the risk of more bank angst. He also sees recession risks running higher along with further earnings downgrades amid tightening financial conditions, all of which could weigh on the markets.
“Even if the banking crisis is contained, US banks will tighten their lending standards further and this could hurt the economy and strengthen the case for a recession. Also, almost all Fed hiking cycles in the past resulted in a recession,” he says.
That said, he also acknowledges that valuations in the markets are not high with a lot of idle cash on the sidelines looking for buying opportunities.
“Market volatility and intermittent pullbacks can offer opportunities for careful long-term investors with the patience and risk appetite to accumulate gradually on sharp dips,” he writes.
“In a nutshell – be nimble, stay defensive, focus on quality, and invest carefully and gradually with a mid to long-term view. Crisis can offer opportunities for those with the risk appetite and the ability to hold and patience to accumulate,” he adds. “In fixed income, we favour developed markets (DM) investment grade bonds, which tend to be recession hedges. In equities, we have an overall neutral position, with an overweight position in Asia ex-Japan. We are also positive on Chinese equities.”
See Also:
Click here to stay updated with the Latest Business & Investment News in Singapore
Fed opts for hike-and-see in gamble that crisis will stay contained
Analysts remain 'overweight' on Singapore banks; SVB seen as a 'non-event' for the sector
Get in-depth insights from our expert contributors, and dive into financial and economic trends
