This week, we also saw the Fed show resilience with a 25 bps rate hike.

Last week, the ECB showed a clear demarcation between monetary policy and financial stability by going ahead with a "promised" 50 bps rate hike. This week, we also saw the Fed show similar resilience with a 25 bps rate hike.

Many experts believe that there are two major issues from here.The first is whether there are significant liquidity strains. The second is whether investors take such significant hits from the decline in asset prices that it sets in motion a plunge in asset prices that stops central banks in their tracks. For instance, many have been surprised that bond holders—specifically additional tier-1 bond holders—took a bigger hit in the UBS takeover of Credit Suisse than shareholders. While this might have reflected the correct ordering in this particular case, it still appears possible that holders of additional Tier 1 bank bonds lose their nerve.

In addition to this, there appear to be lots of places where traders and investors have been hit hard by recent events. The data, which runs up to March 7th, shows that, not long before 2-year yields plummeted from 5.08% to 3.7%, speculative traders had the highest number of short positions on record. We can presumably multiply this out to cover other non-speculative traders in US bonds as well as both speculative and non-speculative traders in rate markets elsewhere.

Should losses on these positions create financial strains, we could see cascading risk across financial markets that pushes the likes of the Fed further away from pursuing its monetary policy objective and more towards carrying out its financial stability responsibilities. In the past, it does seem as if banks and other financial—and non-financial—institutions have been able to absorb losses reasonably well given the scale of some of the shocks, such as the pandemic. But more recently, with the pensions crisis of last September in the UK and Silicon Valley Bank’s demise in recent weeks, it may be that asset price slumps are starting to have deeper impacts and possibly starting to provoke contagion effects.

Other central banks will also be making difficult policy decisions this week, not least the SNB after helping to orchestrate UBS’s takeover of Credit Suisse. Prior to the takeover, the consensus was for a 50-bps rate hike to take the key rate to 1.5%, and after the weekend takeover, the consensus still appears the same. The rise in inflation would certainly seem to justify higher rates, but it is clearly hard to judge whether the SNB will see the current environment as just too uncertain to risk a hike.

The Standard Bank still leans toward the view that rates will rise, as we do in the UK, although here the MPC is seen raising rates by 25 basis points and thinks that this may prove to be the last one in the cycle. All central banks, including the BoE, will have to keep in mind that even if banking tensions do not escalate, there will be a cost in terms of growth, and this could aid the fight to lower inflation and so reduce the need for rate hikes.

Prior to the recent banking strains, it did seem that there was some optimism building about the growth outlook, both in the UK and elsewhere. But many experts suspect that this optimism has been set back now and, in very general terms, recessions become far more likely when banking crises emerge, and it has not changed the call it had before the crisis that the UK is likely to fall into a recession with similar downturns still likely in the euro zone and the US. This should mean a longer-term trend of falling yields, although we do see yields correcting a bit higher in the short term as banking fears slowly ease.