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March 27, 2023

Chart of the Week: The re-pricing of US interest rates has gone too far

by Fathom Consulting.

The re-pricing of near-term US interest rate expectations that occurred in the week following the collapse of Silicon Valley Bank (SVB) on 10 March was as dramatic as any since the stock market crash of 1987. Can this be justified? Let us assume investors currently have in mind two scenarios. Either we are on the verge of a banking crisis similar to the Global Financial Crisis (GFC) of 2008-09, and the Federal Reserve is set to cut aggressively, taking rates rapidly back down to the zero lower bound; or we are not, and the US economy evolves more or less as expected prior to the collapse of SVB. In this simple, bi-polar world, the 150 basis-point fall in the year-end federal funds rate implied by futures prices, from around 5.5% to around 4.0%, would suggest that investors attach around a 25% weight to a re-run of the GFC. For Fathom Consulting, that implied probability is too high. What if concerns about a re-run of the GFC fade over the next few weeks, and market pricing for US interest rates returns to the levels seen in early March? Then we are in a world where the US policy rate is expected to be more than 150 basis points above the Fed’s estimate of neutral for at least the next four years, even though many economists, and many investors, see a real prospect of recession. From our perspective, rates implied by federal funds futures are a little too low in the near term, but substantially too high further out.

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The views expressed in this article are the views of the author, not necessarily those of Refinitiv Lipper or LSEG.

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