Why SVB's collapse is a sign of the "thunder" after the economic "lightning"

Tue 14 Mar 23, 3:11pm (AEST)
Source: Source: Livewire

Key Points

  • The Fed seeks to create downdraft, with collapses of two regional banks being symptoms of tight monetary policy
  • BlackRock's thesis includes pricing damage, rethinking bonds and living with inflation
  • BlackRock's team is underweight equities and overweight government bonds, and Australian investors may not be immune to global market impacts

If you were ever scared of storms as a child, then you may want to brace yourself for this wire. BlackRock's base case has shifted from a probable central bank mistake to one that is far more probable. 

"The Federal Reserve is actively wanting to create a downdraft," says Ben Powell, Chief Investment Strategist for the Asia Pacific region at the BlackRock Investment Institute. 

Powell also argues the Federal Reserve is "highly reluctant" to change its tune. In his view, the collapses of Silicon Valley Bank and Signature Bank will not be enough to stop the Fed from hiking rates by another 25 basis points next week.

In fact, it's less of a chance to pause and more of a chance to observe the damage that the rate hikes will inflict on the financial system. Or as he puts it, the "thunder" after the rate hiking "lightning". 

In this wire, I'm going to take you through BlackRock's most recent views on the market, which feature some extremely defensive and ex-consensus calls. In addition, we'll get some insight into the ETF flows seen under the company's ETF brand (iShares) with Powell's colleagues Katie Petering and Tamara Stats. As they say, the flows don't lie.

Three-pronged thesis

BlackRock's central thesis is essentially three-fold:

  1. Pricing the damage (central banks have induced a mistake)

  2. Rethinking bonds (short-term government bonds preferred)

  3. Living with inflation (rates need to stay higher for longer)

"Coming into this year, we were in between the thunder and lightning. You had, in 2022, the monetary policy lightning and then there's that strange moment in between the lightning and the thunder," Powell says. 

The thunder is coming but we just don't know when.

He adds the collapses of the two regional banks are symptoms of what happens when monetary policy is tightened so dramatically.

Unsurprisingly, given all this, the BlackRock team is underweight developed market equities and overweight government bonds (the "safer part of the bond market", as he puts it).

For the record, the house view is for a 5.25% terminal rate from the Federal Reserve, to be reached later this year.

Will Australia be immune?

The ASX 200 has been more resilient in recent market downturns compared to our global counterparts. That's partly due to our heavy commodities weighting, which in turn, is due to the past strength of the Chinese economy. Incidentally, BlackRock has a 6.1% growth target for the Chinese economy - higher than most of its peers. But it doesn't mean Australian investors will be immune to the global carnage.

What we see is strong wages inflation in Australia in particular," Petering says. "We think the RBA has no choice but to continue to hike to address those issues.

Petering's biggest concerns are two-fold. First, the Australian consumer continues to be more buoyant and optimistic than those offshore. The proof of this can be seen in the retail sales data. The other is the housing market and how the transmission mechanism (translation: the process in which monetary policy hits the economy in waves) will develop. 

"We're not seeing that flow through to the consumer just yet," she adds. 

Petering and her team are also (unsurprisingly) moving away from the pro-risk and growth bias in their asset allocation strategy. That is, a preference for Australian Dollar and US Dollar-denominated short-term bonds and defensive credit-centric assets.

The flows don't lie

If you ever wanted to know what investors might be doing instead of just what they are saying, ETF flows provide some fascinating clues. For Tamara Stats at iShares, it's all about the maxim that "bonds are back". 

"The flows don't lie. Bond ETF flows dwarf equity ETF flows," Stats says. 

She isn't kidding. Year-to-date, bond ETF inflows globally are around US$18 billion while equity ETF outflows are at around US$9 billion. Within the bond market, the short-term Treasury ETF (NYSE: SHV) has been gaining a lot of action with February attracting record inflows for its ETF. 

Locally, the company's cash-like ETF (ASX: BILL) received $90 million in inflows last month alone. The locally-listed corporate bond ETF (ASX: IHCB) also attracted $46 million in inflows, highlighting bids right across the fixed income spectrum.

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Written By

Hans Lee

Content Editor

Hans is a Content Editor at Livewire Markets and Market Index. He created Signal or Noise and helps write the LW-MI Morning Wrap on Tuesdays and Thursdays.

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