Bond markets have made a dramatic reassessment of future rate moves by central banks in the wake of the Silicon Valley Bank failure and bailout - including that of the Bank of Canada.
Swaps-based implied probabilities of future moves by the Bank of Canada suggest decent odds of a quarter-point cut at its next meeting on April 12. And markets are pricing in at least 50 basis points of interest rates cuts by this summer.
As of Friday, when U.S. jobs data hinted at disinflationary trends and news emerged of the collapse of Silicon Valley Bank, money markets were priced for a strong likelihood that the Bank of Canada would be on hold for the rest of this year. Prior to that news emerging on Friday, they were even pricing in a quarter point hike by mid year.
Explainer: What happened to Silicon Valley Bank, and what its collapse means for banks and investors
This morning, the market’s assessment of future Bank of Canada moves has shifted with a speed seldom seen. It was accompanied by a big dive in bond yields, especially in shorter-term issues. The Canadian 2-year bond yield, for instance, is down nearly 40 basis points, to 3.58%, largely tracking the move in 2-year U.S. Treasuries. The U.S. 2-year treasury yield is set for its biggest one day fall since 2008.
Changes in central bank policy rates are particularly felt on the shorter end of the bond yield curve. They also directly impact variable mortgage rates and many other forms of credit.
At last check, the Canada 5-year bond yield, highly influential on fixed mortgage rates, was down more than 30 basis points and retesting its lows for this year.
Here’s what Refinitiv Eikon data is showing as of 10:25 a.m. ET for what credit markets are pricing in for the Bank of Canada’s overnight rate.
The current Bank of Canada overnight rate is 4.5%. While the bank moves in quarter point increments, credit market implied rates fluctuate more fluidly and are constantly changing. And they are particularly volatile at the moment, with significant shifts from minute to minute.
As of this writing, the bond market suggests about a 40% chance of a Bank of Canada cut next month. By August, it’s pricing in a near certainly that there will be a cut.
A similar reassessment is underway over future moves by the Federal Reserve.
On Sunday, the U.S. administration took emergency steps to shore up banking confidence, guaranteeing deposits after withdrawals overwhelmed Silicon Valley Bank and closing under-pressure lender Signature Bank in New York.
But while stock futures rose in relief, bond markets opened in Asia with a furious race to re-price rate expectations on the thinking that the Federal Reserve can only be reluctant to hike next week while the mood is febrile and delicate.
“The market thinks that this is not just SVB (Silicon Valley Bank), but several banks. The sharp rise in policy rates and sovereign yields over the last year and a half has put a lot of banks under stress,” said Stan Shipley, fixed income strategist at Evercore ISI in New York.
“The consequence is that the outlook for rates is not going to be as high as previously thought. Last Wednesday, you had people thinking 6% (peak Federal Reserve funds rate) is a sure thing. I don’t think anybody thinks that now,” Shipley added.
Bank stress and the resultant shakeout of loan books mean higher borrowing costs, said Akira Takei, fixed income portfolio manager at Asset Management One in Tokyo, with the resulting pressure in the real economy making further hikes difficult.
“If (U.S. Fed Chair Jerome) Powell lifts interest rates next week, he will jeopardize this situation,” he added. “If they don’t prioritise financial stability, it’s going to (breed) financial instability and recession.”
A late-Sunday note from Goldman Sachs, in which the banks’ analysts said the banking stress meant they no longer forecast the Fed to hike rates next week gave the rates rally an extra leg in the Asia session.
At 4.05%, U.S. two-year yields are below the bottom end of the Fed funds rate window at 4.5% - a sign markets see rates’ peak is near.
The latest futures pricing implies a near 40% chance the Fed stands pat next week and an 60% chance of a 25 bp hike - a huge shift from last week when markets braced for a 50 bp hike.
“I think people are linking Silicon Valley Bank’s problems with the rate hikes we’ve already had,” said ING economist Rob Carnell.
“If rates going up caused this, the Fed is going to mindful of that in futures,” he said. “It’s not going to want to go clattering in with another 50 (bp hike) and see some other financial institution getting hosed.”
Monday’s early moves also sharply pulled forward and pushed down market expectations for where rates peak. From about 5.7% on Wednesday, implied pricing for the peak in U.S. rates was testing 5% on Monday and year-end expectations - above 5.5% last week - tumbled to about 4.7%, a drop of some 80 basis points in days.
With files from Reuters
Darcy Keith