Investment Institute
Macroeconomics

Testing the Separation Principle


  • We think the drastic downward revision in central banks’ terminal rate is overdone
  • The current banking turmoil could trigger a steep deterioration in activity, but at this stage, some circuit breakers can still help.

Markets reacted to the continuation of the banking turmoil last week by drastically revising down their expectations for the Fed and the ECB’s policy rate, expressing their scepticism at the possibility that central banks could respond to the financial stability issues with liquidity measures alone, without altering their policy stance. While we agree that more prudence is warranted in the pace of tightening – we think that in the case of the ECB resorting to 25 bps hikes rather than the recent increments of 50 bps should be way forward - central banks are likely to balance the already tangible signals that inflation is taking too much time to decelerate with the mere possibility that the banking stress triggers a steep deterioration in economic activity and hence dampens inflationary pressure.

We don’t want to downplay the importance of what’s going on. In the US, deposit migration from smaller to larger banks would not be neutral from a macroeconomic point of view. Small banks exhibit in general a much higher loan to deposit ratio than their larger competitors, and they play a crucial role in a sector – real estate – which is already under significant pressure. Higher banks’ funding costs – if the risk premium drifts higher – would be another transmission channel (we find a quite tight correlation between banks’ refinancing gaps and their lending standards to firms). Yet, some circuit-breakers exist. In aggregate terms, small banks in the US have comparatively less interest-rate sensitive securities on their balance sheet than their larger counterparts (this was a specific issue for SVB). The solution for Credit Suisse found with UBS (and the decisive support from the Swiss government and central bank) implies a write-down of the AT1s, but bonds higher up the seniority ladder seem to be protected. 

Confidence always plays a major role in banking crises. In the 1980s, it took years to finally deal with the Savings and Loans saga (which bears some resemblance with the current US predicament). This time, public authorities are clearly intent on acting big and fast.

Testing the Separation Principle
Download the full article (564.07 KB)

Related Articles

Macroeconomics

Electrify Europe

Macroeconomics

October Op-ed - Meeting in the middle

Macroeconomics

October Monthly Investment Strategy - A far-reaching US election

    Disclaimer

    This website is published by AXA Investment Managers Asia (Singapore) Ltd. (Registration No. 199001714W) for general circulation and informational purposes only. It does not constitute investment research or financial analysis relating to transactions in financial instruments, nor does it constitute on the part of AXA Investment Managers or its affiliated companies an offer to buy or sell any investments, products or services, and should not be considered as solicitation or investment, legal or tax advice, a recommendation for an investment strategy or a personalized recommendation to buy or sell securities. It has been prepared without taking into account the specific personal circumstances, investment objectives, financial situation or particular needs of any particular person and may be subject to change without notice. Please consult your financial or other professional advisers before making any investment decision.

    Due to its simplification, this publication is partial and opinions, estimates and forecasts herein are subjective and subject to change without notice. There is no guarantee forecasts made will come to pass. Data, figures, declarations, analysis, predictions and other information in this publication is provided based on our state of knowledge at the time of creation of this publication. Whilst every care is taken, no representation or warranty (including liability towards third parties), express or implied, is made as to the accuracy, reliability or completeness of the information contained herein. Reliance upon information in this material is at the sole discretion of the recipient. This material does not contain sufficient information to support an investment decision.

    All investment involves risk, including the loss of capital. The value of investments and the income from them can fluctuate and investors may not get back the amount originally invested. Past performance is not necessarily indicative of future performance.

    Some of the Services and/or products may not be available for offer to retail investors.

    This publication has not been reviewed by the Monetary Authority of Singapore.