Dodd-Frank regulations introduced post-2007/08 were designed to protect the US financial system from a repeat of the financial crisis. The capital buffers of the ‘fortress’ banks – the GSIBs – would be large enough to prevent ‘systemic’ risk from unfolding. Once a bank run begins, pragmatism should always trump, and the response by regulators was swift. Deposits are still fleeing smaller banks. But the move to park deposits in larger banks suggests confidence in the broader financial system remains intact.
The magnitude of the drop in the 2-year Treasury yield has been unprecedented. It is also overdone. If anything, the drop in real yields, and a rally in the S&P 500 this week, as fears over the banking sector subside, may in the end lead to a material loosening of financial conditions.
It may seem facetious, but attention may turn quickly back to the CPI. By the time of the next FOMC meeting, Treasuries may have repriced back to more realistic levels. There is little control on government spending, making the task of bringing inflation down even more challenging.
The FOMC may raise rates by just 25 bps. But it wouldn’t be a surprise to see the Fed place emphasis upon the success of Dodd-Frank, the solidity of the largest banks, and their swift action in response to SVB. They will want to signal, in effect, that regulators have the tools to deal with financial stability concerns, while monetary policymakers should remain focussed on tackling inflation. Indeed, the most wage-sensitive components of the services CPI have recently accelerated.
The services CPI ex-shelter, energy, & medical care jumped 0.69% m/m in February, the strongest m/m rise since July 2020. The y/y for this category of core domestic services prices accelerated to 5.22%, a new secular high.
