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Between a Rock and a Hard Place ⚠️

On Thursday, the ECB raised rates by another 50 bps taking rates to 3.5%. The Fed is scheduled to take a rate decision next week. So far, through last year, rate hikes were obvious. However, the last couple of weeks has put central banks in a tight spot.

If they hike the rate, there is a problem. If they don’t hike too, there is a problem. Either way, one thing is for sure, the outlook for Western economies is deteriorating, and that increases the overall risk level.

What’s happening?

SVB’s collapse, at large, was driven by high rates. And Credit Suisse, while it comes with its own baggage also had higher rates to deal with. For both of these banks to not cause a domino effect and eventually result in the collapse of the banking system, the Fed and ECB had to step in and take steps to save them (without using the b-word).

No more rate hikes

While saving these banks was done swiftly, the events have unfolded the fragility of banks and highlighted the vulnerability of the banking system. Clearly, rate hikes are hurting. And any more rate hikes would only increase the pain for banks, and for the financial markets.

More rate hikes, please

But central banks can’t even afford to not hike rates. Inflation is still way higher than the comfort level of 2%. In February 2023, inflation in the US was at 6%, and that in the EU was at 8.5%. Although it is declining from its highs, inflation is still stubborn, sticky and high. More rate hikes would be needed to tame inflation.

What next?

Central banks may do both! Either way, hike or no hike, there is trouble. Bank failures on one hand, and recession on the other hand.

In the US, in just the last week, banks took loans to the tune of US$ 165 billion from the Fed’s discount window (the place where banks can borrow money from the central bank) and a new emergency loan program that it announced after SVB’s failure. This is the most money borrowed since 2008.

The Fed’s balance sheet grew by nearly US$ 300 billion in just one week, reversing half the progress it had made through quantitative tightening, it had taken up in November 2022 to curb inflation. Effectively, the Fed is already pumping in extra liquidity into the market to save banks, while it may also raise rates by another 25 bps in its next meeting to curb inflation.

That’s what happened in Europe too. The Swiss National Bank extended a loan of CHF 50 billion to help Credit Suisse clean up its mess, while the ECB in the same breath, also hiked rates by 50 bps to curb inflation.

What about India?

The outlook for global equities doesn’t look all that rosy. While all this is happening far away from India, there are a few risks that the Indian markets aren’t immune to, and are likely to result in downward pressure on the markets:

  1. Exports for India may see a significant slowdown

  2. Recent events have been triggering a flight to safety

  3. The overall risk appetite for equity has been going down

Also, India is facing its own problems, even though they may appear as classic ‘rich people problems’. Inflation is high in India too, but the risk on the other side is just slower growth and not a full-blown financial crisis.

Long story short, the Indian markets have a lot more downward pressure right now, relative to upside triggers.

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