The instability that the collapse of Silicon Valley Bank has introduced into the economic picture has been enough to inspire hope that the Fed might change course from the hawkish stance outlined by Chairman Jerome Powell last week, according to David Kelly, J.P. Morgan Asset Management’s chief global strategist.
“If you go back to last Wednesday, people were pricing in between 100 and 125 basis points [in rate hikes],” Kelly said during a press call today. “By Friday, they had taken a lot of it out. Even since 6:00 this morning, markets have moved. If you look at the Fed funds futures market, the markets are narrowly holding onto the idea that the Federal Reserve will raise rates by 25 basis points in March, but that's it. They won't raise rates further. Markets are also pricing in the idea that the Federal Reserve will cut rates later on and cut rates a number of times in 2024.
“That's a very dramatic move,” he emphasized. “We've seen the 10-year Treasury yield go back from over 4% at the start of this month to about 3.45% before this call started.”
More volatility lies ahead, he said, and so financial advisors should have a structure for explaining the different components of the problem to clients, and then tweak aspects of that structure as the story continues to develop.
“We've been through many crises over the years—the financial crisis, the pandemic recession, other variants of banking crises over the years,” he said. “I think the correct thing to do is come up with a structure and go through the pieces, and as events unfold you can change how you think about different parts of the story. But you've got a structure behind the story.”
Kelly’s structure included a summary of what happened with the collapse of Silvergate ($11 billion in assets under management), Silicon Valley ($200 billion in AUM) and Signature ($110 billion in AUM) banks, why they happened, how the government has responded, how markets have responded, what it means for the economy and the Fed’s monetary policy, and finally what it means for investing.
Of course, clients are going to want to know how all that will affect their portfolios and impact their life plans, he said.
“We shouldn't make predictions about the short-term back and forth. It can be frenetic,” he said, adding that there will most likely be several waves of anxiety-producing headlines before the dust settles. “The question is, does it do long-term economic damage? What we found in the past is if you have a crisis that affects markets and it doesn't impact the economy in a significant way, then markets recover.”
The economy has remained robust in terms of new jobs, overall employment and retail sales, Kelly said. And while the economy has been slowing, it’s been very gradual, not a dramatic crash.
“I believe that whether the Federal Reserve raises rates or not, whether we have a recession or not, I believe inflation will come down steadily,” he said. “By the middle of this decade, we will be asking the question how can we get inflation up to 2%, not how can we get it down to 2%.”
If the SVB crisis has enough blowback to trigger a more dramatic slowing of the economy and nudge the U.S. into recession, Kelly said he expects the government to protect the financial system to prevent a repeat of 2008.
“We may be on the edge of something, but I hold with the view that we are on the edge of a swamp, not the edge of a cliff,” he said.
This means, he said, that while the Fed might raise rates another 25 basis points next week, it also might not.
“I think it's more likely the Federal Reserve will just, out of caution, decide to pause,” he said. “And if they do pause, they'll find they've got little reason to get going again.”
So for investors, he said, avoiding getting caught up in a crisis mentality is best. There will be market volatility and even some contagion, but he reminded his audience that people have a habit of getting out of the market when they’re scared and re-entering when they feel comfortable, which is little more than a recipe for selling low and buying high.
“We don't know the full fallout here. But if you look forward a few years, I think what this does is it suggests that if anything, by 2024 we're going to have a lower-rate environment than we thought we were going to have. As long as the economy is stabilized, that environment should support higher stock prices and bond prices,” he said. “So take a deep breath, understand what's going on, keep updated on what's going on. Have a structured approach to examining what's going on. But this is a time to stick with a long-term plan.”
Kelly also addressed weekend rumors that various entities, including J.P. Morgan, were looking at buying SVB.
“I'm not privy to any of the negotiations or behind the scenes stuff that was going on,” he said.
“I will say as a general rule, a lot of banks that were in the buying of other financial institutions business back in 2008 feel little bit bruised by that experience,” he said, concluding that an SVB takeover is perceived a bit like trying to catch a falling knife.