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ResearchDecember 4, 2023

When Will Interest Rates Fall and by How Much?

UBS analysts think the Fed will need 6 months or so to realize it can ease, gradually slicing the central bank’s benchmark by a modest amount, up to 0.75 points.

By Larry Light

Wall Street is convinced the Federal Reserve will cut rates next year, and the only questions are: When will the reductions start, and how deep will they go? Representatives from the Fed, for their part, wave away talk about reversing the tightening campaign, saying it is not clear that rising inflation is vanquished.

Still, investment firms are not convinced today’s rate level will persist, with the UBS view a prime example. The bank’s strategists argued in a note that the Fed will lower rates by next summer as it comes to realize that its benchmark is perhaps one percentage point too high for the economy’s health. By mid-year 2024, the thinking goes, inflation should be down sufficiently to permit a reduction.

The cuts, however, will be, in UBS’s estimation, up to a total of 0.75 points. If so, that would put the rate closer to the long-term average (since World War II) of 4.6%. “Our base case is that the Fed will deliver two to three cuts next year, with the timing data dependent, but most likely starting in July,” the report stated. UBS reasoned that “policymakers will be sufficiently confident by mid-year that inflation is falling sustainably toward target to begin cutting rates.”

UBS and other firms hear Fed Chair Jerome Powell say that the benchmark federal funds rate (now in a band from 5.25% to 5.5%) is “restrictive.” By their reasoning, Powell will not want to keep rates that high for too long, lest economic growth suffer. Already there are indications that the economy may be downshifting, with hiring off from its highs and consumer spending decelerating.

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Also helping to fuel expectations of Fed easing is that inflation has indeed cooled, although not yet reaching the level the central bank wants. The Personal Consumption Expenditures Index, the Fed’s preferred inflation gauge, was 3% yearly as of October, its smallest year-over-year gain since March 2021 and down from 3.4% in September. The Fed’s PCE target is 2%.

The betting in the futures market is for five reductions, each by one-quarter of a point, by December 2024, with 60% odds that the first cut comes as early as March. The wagering is almost unanimous that the Fed’s policymakers will do nothing at their meeting on December 12 and 13.

The bond market has begun to reflect the easing expectations: The 10-year Treasury yield has tumbled to 4.4%, as of Friday, from near 5.0% in mid-October. Meanwhile, over the same period, the two-year Treasury has slid to 4.7% from 5.1%.

The UBS note pointed out that statistical progress on inflation and the bond market’s performance, a good gauge for investors’ views on Fed policy, will not move in a straight line in coming months. Exogenous events, such as international tensions, always can crop up to disrupt rosy scenarios.

The memory is strong of 2021, when inflation jumped in the spring and then subsided in the summer, giving the Fed false hope that the surge was, in Powell’s words at the time, “transitory.” Amid supply-chain snafus, prices resumed their ascent in the fall.

The hope—and expectation—is that next year’s story will be different.

Norges Bank, AP7 Named Co-Lead Plaintiffs in Silicon Valley Bank Lawsuit

The institutional investors lost a combined total of nearly $162 million from investments in the bank’s holding company, SVB Financial Group.

By Michael Katz

A U.S. federal court has named Norwegian central bank Norges Bank Investment Management and Swedish pension giant AP7 co-lead plaintiffs in a class action lawsuit related to the collapse of Silicon Valley Bank. It is the first time Norges Bank, which also manages Norway’s nearly $1.5 trillion sovereign wealth fund, will lead a class-action lawsuit.

The decision by U.S. District Judge James Donato, presiding in U.S. District Court for the Northern District of California, was primarily based on the institutional investors having “the largest financial interest in the litigation.” According to court documents, Norges and AP7 have suffered losses of approximately $138.4 million and $23.5 million, respectively, from their investments in SVB Financial Group, the bank’s parent holding company.

“We manage money on behalf of all Norwegians. I see it as our duty to take legal action to both maximize our recoveries after the SVB collapse and to signal that this is not acceptable market behavior,” Norges Bank Investment Management CEO Nicolai Tangen said in a statement. “Given our role as co-lead plaintiff, our aim is to maximize recoveries of all investor losses.”

The lawsuit alleges that SVB Financial and certain of its executives misrepresented the strength of the bank holding company’s balance sheet, liquidity and position. The plaintiffs claim the defendants understated and hid the magnitude of the risks the company faced from any decision by the Federal Reserve to raise interest rates. The lawsuit also claims the alleged misrepresentations and omissions caused the bank’s stock to trade at artificially inflated prices.

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The lawsuit names as defendants Silicon Valley Bank’s president and CEO, Greg Becker; chief financial officer, Daniel Beck; chief accounting officer, Karen Hon; and chairman Roger Dunbar, along with others at the company director level. Goldman Sachs, Bank of America Securities, Morgan Stanley and Keefe, Bruyette & Woods are also named for allegedly violating the Securities Act.

In choosing Norges Bank and AP7 as co-lead plaintiffs, the court also denied a request by KBC Asset Management, a unit of Belgium’s KBC Corp., to be the lead plaintiff instead.

“[KBC] has not shown that the group of Norges and AP7 is the product of lawyer-driven efforts,” the court’s decision stated. “It bears mention that Norges does not need its losses aggregated to secure lead plaintiff status: standing alone, its losses eclipse those of other movants.”

According to Norges Bank, the Government Pension Fund Global has a dedicated staff of in-house U.S. litigators to oversee the litigation.

Sweden’s largest pension fund, Alecta, which reported losing 19.6 billion Swedish kronor ($1.9 billion) from its investments in Silicon Valley Bank, First Republic Bank and Signature Bank, said in an email that it is a passive class member in the lawsuit.