Meritz "Expectations for Rate Freeze and Pivot Due to SVB Bankruptcy Are Overblown"

Cause of SVB Crisis 'Bond Loss'... Control Variable
"Different from 2008 Systemic Crisis"
March 25bp Rate Hike Expected
US 2-Year Treasury '4.25~4.50%' Likely
US 10-Year Treasury at 3.7% ±30bp

Yoon Yeosam, a researcher at Meritz Securities, evaluated that expectations for the U.S. Federal Reserve (Fed) to either hold interest rates steady this month or pivot (direction change) in June following the bankruptcy of Silicon Valley Bank (SVB) are excessive.

[Image source=Reuters Yonhap News]

On the 16th, Researcher Yoon stated, "At the March Federal Open Market Committee (FOMC) meeting, attention should be paid to a 25 basis point increase and the assumption of a terminal rate of 5.5%, along with reduced interest rate volatility."

He noted that the current moment calls for maintaining a balanced approach between the robustness of the real economy and financial instability, emphasizing prudence in policy response. This phase is similar to, yet different from, the 2008 crisis.

Before the 2008 financial crisis, the key starting point was that the U.S. maintained a prolonged low-interest-rate environment from the 2000 dot-com bubble collapse through the 2003 China shock, accompanied by significant expansion of household debt centered on real estate. Consequently, the Fed raised the federal funds rate from 1.00% in June 2004 to 5.25% by July 2006.

During the roughly one-year period of maintaining rates in the 5% range until 2007, problems arose in household credit, especially mortgages. Ultimately, the Fed pivoted in the second half of 2007, lowering rates to 2.00%.

The biggest similarity in the current phase is the Fed's monetary tightening. The 2004 rate hike cycle involved baby steps raising rates by 400 basis points over two years. Currently, rates have been increased by about 500 basis points in just one year, indicating an excessively strong tightening.

[Image source=Yonhap News]

Nonetheless, evaluations suggest that unlike in 2008, the current phase is less likely to fall into systemic risk. This is because the root cause of insolvency lies in 'bond losses.'

Researcher Yoon pointed out, "In 2008, bond market valuation losses due to mortgage defaults were significant, but at that time, leveraged derivatives such as collateralized debt obligations (CDOs) and credit default swaps (CDS) had a major impact. The shadow banking system then caused uncertainty of an unmeasurable scale and spread, whereas the current unrealized valuation losses are variables controlled by individual financial institutions."

Another notable aspect is the flight to safe assets, which can be observed in the correlation between interest rates and the dollar. Since COVID-19, excessive liquidity effects have caused the economy and monetary policy to move in the same direction, resulting in the dollar and U.S. Treasury yields moving together. Currently, as Fed tightening expectations ease, both interest rates are falling and the dollar is weakening. The concern is that if the market shifts to an extreme safe-haven phase where the dollar strengthens despite falling rates, caution is needed for risk investments.

Researcher Yoon criticized, "On the 13th, the yield on the 2-year U.S. Treasury dropped 61 basis points in one day from 4.59% to 3.98%. While the 100 basis point rise in February was excessive, the 100 basis point drop in just three days is also excessive."

He emphasized, "Regarding the outlook for U.S. monetary policy, I expect the upcoming FOMC to implement a 25 basis point hike, with the debate focusing on whether the terminal rate will reach 5.50% by June. Maintaining a balanced stance is crucial."

He added, "If the SVB incident does not escalate into a systemic crisis, the 2-year U.S. Treasury yield is likely to range between 4.25% and 4.50%, centered on expectations for the federal funds rate. For the 10-year U.S. Treasury, it is appropriate to anticipate movements of about 30 basis points around a central line of 3.7%."

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