Vimal Gor: This is the moment you've been waiting for
The recent Silicon Valley Bank (SVB) saga has effectively kickstarted a quantitative easing cycle, Vimal Gor says - now the Chief Investment Officer of Trovio Group - and the implications bode exceptionally well for risk assets.
For those not in the know, the collapse of SVB, the 16th largest bank in the US, has inspired nightmarish flashbacks of the Lehman Brothers bankruptcy of 2008 - then the fourth largest bank in the US.
Aside from the obvious fact that very few local investors would have heard of SVB before last week, and that the Federal Deposit Insurance Corporation has since stepped in to save insured depositors, concerns are growing that SVB is the first domino to fall as a result of the Fed's aggressive rate hiking cycle. That is, until a few days ago.
"Effectively what's happened is [the Fed has] now started quantitative easing," Gor explained.
"I've been very vocal about the fact that the market and the world need quantitative easing because we can't handle higher interest rates. So the Fed is in this bizarre situation now where they've hiked rates very aggressively, done quantitative tightening and then, in the last few days, are doing quantitative easing.
"They are now doing quantitative easing and quantitative tightening at the same time."
The re-introduction of quantitative easing has three implications for markets, Gor argues. Firstly, this is the peak of the rate cycle. Secondly, the liquidity taps have been turned on again (which should see long-duration assets benefit) and third, that bond yields should go lower from here.
So where did this all begin? And what can investors expect from here? In this wire, I'll summarise Gor and Portfolio Manager Thomas Ciszewski's latest market update to investors.
Note: These quotes were taken from a market update video posted on Trovio's LinkedIn.
How did we get here in the first place?
This story begins after the market chaos of the Global Financial Crisis, Gor explained, after the US Federal Reserve slashed rates to all-time lows.
"They pumped a lot more money into the system post the pandemic as well, and recently, in the last year or so, they have been hiking rates very aggressively to deal with the growing inflation problem," he said.
"That inflation problem was started by supply-side constraints around the pandemic, the monetary and fiscal policy that was pumped into [the economy] around that time, plus the deglobalisation that was happening."
So, as we all know too well, the Fed began on its aggressive hiking cycle, but as Gor puts it, "this was always going to come back to bite them."
"We've been waiting to see where the first ripples of discontent were going to be in the market, and they came very loud and clear last week around the regional banks," he said.
"Ultimately, what's happened is the regional banks aren't able to fund themselves and run a proper business model, because the yield curve is inverted. So they are unable to borrow short and lend long, which is the normal model, so they've kept deposit rates at very low levels."
This has meant that money has been leaving the regional banks and going into money market funds, he added.
"As we have seen, this outflow of depositors stressed the banks, and that's what has ultimately caused the run," Gor said.
"So we have seen the FDIC come in and backstop the regional banks - they've made good all of their loans, they've insured all depositors over the US$250,000 level, where previously you weren't insured, and they've allowed those banks to pledge collateral back to the Fed at par."
Where are we going?
With this move, the Fed has effectively started quantitative easing, Gor explained. So what happens from here?
"We think there are a few takeaways. One is that the Fed rate cycle is pretty much done now. They might try to squeeze out one more hike, but we think that's it, and the next material move in rates will be lower," Gor said.
"Secondly, the quantitative easing we are seeing is the turning on of the liquidity taps, which should be good for risk assets and it certainly should be good for crypto and equities."
That said, Gor believes US GDP growth is likely to suffer.
"So we expect the soft landing scenario, which had become market consensus, to be turned on its head, and the market will start looking for a much deeper recession," he said.
"That means bond yields should go lower from here and I'd be very wary of credit spreads."
"We've seen peak rates"
Trovio Group Portfolio Manager Thomas Ciszewski argued that the main implication of this move is that we have now seen a peak in the US Fed Funds Rate.
"If you are wondering where peak rates are going to be, and whether they could get above 6%, well actually, they're going to be a lot closer to 5% - maybe 5.25%, but we don't think so anymore," Ciszewski said.
"What this move has done in a week is it has actually tightened financial conditions - even as yields in the six months and 1-year have fallen by greater than 100bps."
While this may be positive for long-duration assets - which have rallied in recent days - uncertainty remains around the banking cycle both in the US and globally, Ciszewski added.
"How many more balance sheets have this duration mismatch that they will risk insolvency over?" he asked.
"What we are still worried about is the tightening of those banks being able to actually function and offer credit to small businesses and investors. We really don't know what the full implications are now, in the near term, for the broader economy and recession."
This has wider implications for digital assets, Ciszewski argued.
"Digital assets, and especially Bitcoin, were set up to disintermediate the financial system," he said.
"What we've seen is as all kinds of investors are worried about their cash being at certain banks and have used Bitcoin as a safe haven, they've used Ethereum as a safe haven, as you can quickly transfer your fiat currency into those assets and hold them on the blockchain in safe custody."
The price of Bitcoin has surged more than 20% since Friday last week when the collapse was made public. Ethereum has lifted more than 17%. Yes, this shocked me too.
"I think that trend is one of the best use cases we've seen, as we question not only the Fed's policy and this conundrum of switching quickly between quantitative tightening and quantitative easing, but also the whole banking system," Ciszewski said.
"If they can't properly manage small amounts of assets, what is the safety of keeping your funds there?"
With this in mind, the Trovio duo predict that investors are in for a repeat of 2021 again.
"It's clear for us that while we see a lot of equity dispersion, possibly big tech benefiting from this again from a low rate cycle, with other parts of the economy doing poorly again, sort of circa 2021 all over again, we also see this as very positive developments for digital assets," Ciszewski added.
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Ally Selby is a content editor at Livewire Markets, joining the team at the end of 2020. She loves all things investing, financial literacy and content creation, having previously worked for the likes of Financial Standard, Pedestrian Group, Your...
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