Daily Comment (March 24, 2023)

by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Good morning! Today’s Comment begins with an overview of our thoughts on the Congressional hearings for both TikTok and Treasury Security Janet Yellen. Next, we discuss why central banks have decided to raise interest rates in the face of an ongoing banking crisis. Lastly, we explore the reasoning behind China and Russia’s new interest in the Middle East.

Congressional Attention: Lawmakers are looking to bolster their reputation of being tough on big banks and China during hearings on the Hill.

  • TikTok CEO Shou Chew testified before a hostile Congress on Thursday, as officials weigh a potential ban of the social media app. During the hearing, politicians did not shy away from confrontation. Chew, who tried to walk a tight line between being vague and honest, was challenged on his company’s ability to remain independent of Beijing. In one exchange a politician implied that Chew was committing perjury when he refused to say that the social media site does not disseminate material that would upset Beijing. The row over TikTok is likely the first of many fights over whether Chinese firms pose threats to U.S. national security.
  • Meanwhile, Treasury Secretary Janet Yellen’s flip-flop regarding efforts to insure U.S. bank deposits without the approval of Congress has added to concerns that the government may need to rescue the banking system. While speaking to Congress, Yellen walked back remarks that suggested that the Treasury Department was not prepared to expand deposit insurance. Any rescue plan without congressional consent will likely meet pushback as politicians would view unilateral executive action as evidence that banking officials are not being forthright about the severity of the banking crisis. Investors have been paying close attention to Yellen’s remarks for signs of a possible bailout for regional banks.
  • The two separate hearings on banks and Chinese companies reflect a trend away from the Bork rule that defined the period between 1970-2010. Named after former Federal Judge Robert Bork, the rule stipulates that regulations should not be used to interfere with economic efficiency or consumer welfare. This sentiment has been the bedrock of elitist thinking regarding the government’s approach to business but is showing signs of eroding. As the congressional hearings demonstrate, lawmakers would like to prioritize policies that favor state objectives such as national security and bank stability over economic efficiency. If we are correct, this will likely lead to a higher inflationary environment as firms look to push the cost of burdensome regulations onto the consumer.

 Interest Rate Fallout: Major central banks still decided to raise rates despite the ongoing banking crisis.

  • The decision to raise rates indicates that monetary policymakers are hesitant to stop tightening without solid evidence that the banking system’s health has no other fix. Recent liquidity injections by the Federal Reserve and Swiss National Bank have given officials confidence that the worst of the crisis has peaked. In individual statements, the Bank of England, Federal Reserve, and European Central Bank all offered reassurances that the banking system remains resilient amidst the turmoil. Additionally, each bank maintained that they remain committed to bringing down inflation and preserving financial stability.
  • Although central bankers signaled that they are not considering rate cuts, the market seems to believe otherwise. The CME FedWatch tool shows an 80% chance that the Fed will cut rates by its July meeting. Meanwhile, the overnight index swap rates for the GBP and EUR suggest that the BOE and ECB will look to stop hiking around June or September of this year. Movements within the bond market also suggest that investors believe that policy will begin to normalize. As of Thursday, the inversion spread between the 10- and two-year Treasury narrowed by 42 bps since the start of the month.
  • Monetary policymakers want to raise rates but do not want to destabilize the financial system. The usage of the backstops has offered banks some relief from deposit outflows. The latest figures from the Fed show that U.S. banks borrowed $53.7 billion from the Fed’s new Bank Term Funding Facility. However, there is still no guarantee that the turmoil in banking will end anytime soon. The sudden spike in Deutsche Bank’s (DB, $9.65) default insurance costs will likely add worries that the financial system remains fragile. As a result, it is still reasonable to assume that central banks could consider easing monetary policy this year if the banking issues persist.

Middle East Problems: The China-Russia pivot toward the Middle East complicates the efforts of the U.S. to exit the region.

  • Russia and China are working to mediate tensions between Arab countries to help reduce the region’s dependence on U.S. security. On Wednesday, Moscow had announced it was close to restoring diplomatic ties between Saudi Arabia and Syria. The move comes on the heels of several recent successes of China and Russia to calm violence in the region, highlighting the U.S.’s declining importance. Last week, China assisted in restoring diplomatic ties between Saudi Arabia and Iran. Moscow and Beijing may be looking to build their influence in the Middle East to disrupt efforts by the West to isolate them.
  • U.S. foreign policy within the Middle East continues to show signs of disarray. Despite efforts to reduce the U.S. forces within the region, the Pentagon carried out airstrikes in Syria against an Iranian rebel group. The U.S. has about 900 troops in Syria to help with Syrian fighters’ efforts against Islamic State militants. Meanwhile, Israeli Prime Minister Benjamin Netanyahu’s efforts to undermine the country’s Supreme Court and other democratic institutions have frustrated Washington. The Biden administration expressed concerns about the changes to Israeli law earlier this week. The ongoing friction will complicate cooperation efforts between the two countries as they look to take on Iran and expand the Abraham Accords.
  • As the U.S. looks to focus its attention on expanding its influence in the Indo-Pacific, it appears that Russia and China are looking to deepen their ties with Middle Eastern countries. The China-Russia pivot toward the region will aid efforts to reduce their respective reliance on the West. It will also ensure that China can maintain its access to commodities even as its relationship with the U.S. deteriorates, while Russia can use its relationship with Arab countries to undermine the West’s efforts to slow its petro sales through price ceilings.
    • The biggest loser in this scenario may be the European Union, as it is stuck between kowtowing to authoritarian governments that challenge its value or being forced to accept U.S. foreign policy that often challenges its strategic interests.

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