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Markets Rebound on Easing Contagion Fears

Measures of implied volatility are beginning to subside after the collapse of Silicon Valley Bank triggered a week-long spasm in financial markets and led to a wholesale repricing in global interest rates. European bank shares are rallying, North American equity indices are setting up for a stable open, Treasury yields are up, and the dollar is down. Oil is climbing off the 15-month lows reached during yesterday’s session

Credit Suisse shares gained more than 20 percent at the open this morningafter it offered to repurchase debt with up to 50 billion francs borrowed from the Swiss National Bank. The move is expected to bolster balance sheet ratios across what was already a relatively well-capitalized institution, drastically reducing the odds on another share price collapse. “Everything is fine, I don’t think they’ll need more capital,” Ammar Al Khudairy, chairman of Saudi National Bank, said in an interview with CNBC, after sparking yesterday’s panic by saying the largest single shareholder would not offer any more funding: “The answer is absolutely not, for many reasons outside the simplest reason which is regulatory and statutory”.

As suggested yesterday, we think Credit Suisse’s problems are idiosyncratic, largely self-inflicted, and generally unrelated to the monetary tightening efforts conducted by major central banks. Widespread fears of contagion are likely overwrought, and could fade dramatically in coming days.

The European Central Bank will release its latest decision at 9:15 EDT this morning. Until yesterday’s Credit Suisse drama, markets thought policymakers would raise rates by a half percentage point, but doubts have since emerged, with many observers suggesting a quarter point move has become more likely. We’re less convinced – inflation prints keep beating expectations, the economy remains strong, and interbank swap spreads suggest the odds on a continent-wide funding crisis remain low – but a more cautious approach would seem prudent. Language in the statement might be modified to remove references to “further” increases, and to qualify the “data dependent” nature of the bank’s policy stance.

We should note that the post-decision press conference could prove dangerous for markets. A verbal misstep from President Lagarde – famous for having triggered a sovereign bond selloff by claiming the Bank was “not here to close spreads” – could destabilize already-fragile markets.

Europe’s decision could also have direct implications for Federal Reserve expectations. Odds on a quarter-point move at next week’s Fed meeting have moved back up to 75 percent after slipping below 40 percent earlier in the week. The two-year Treasury yield, arguably the most sensitive measure of front-end interest rate expectations, is holding near 3.95 percent, having plunged from 5.05 percent last week in one of the biggest bouts of volatility seen in modern market history. If Lagarde & Co. opt to err on the side of caution, rates could reverse lower once again.

Initial jobless claims slipped to 192,000 in the week ended March 11 from 211,000 in the prior week. Housing starts are seen inching up to an annualized 1.45 million in February, up 9.8 percent from 1.3 million in the prior month. And the Philadelphia Fed’s manufacturing survey might climb to -15.5 in March from -24.3 in February.

But signs of slowing economic momentum are beginning to appear elsewhere: Numbers out yesterday showed retail sales fell a seasonally adjusted 0.4 percent in February, with spending outside gas stations and auto dealers essentially flat. Producer prices dropped 0.1 percent, suggesting an easing in supply chain pressures.

Growth could slow further as tumult in the regional banking sector leads to a reduction in overall lending activity.Estimates published by JP Morgan suggest that – although regional banks make up a relatively small share of overall lending – a slowdown could nonetheless weaken aggregate demand and lower gross domestic product growth by half a percentage point.

But we would note that this is exactly what the Fed has sought – and largely failed – to achieve in its year-long tightening campaign. Policymakers may have hoped to guide growth lower in a less traumatic fashion, but the recent episode of volatility suggests their efforts are finally gaining traction. 

Be careful what you wish for.

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