Bank Failures, Rate Talk and Economic Anxieties
Is the banking crisis finally in the rearview mirror? During March, Silicon Valley Bank (SVB) unexpectedly collapsed after it announced a plan to raise capital. Signature Bank (SB) was shuttered shortly after SVB’s closure.
At the time, it was the second and third-largest bank failures in U.S. history.
First Republic Bank (FRB) was already on shaky ground but had survived by borrowing heavily from the Federal Reserve and government-backed lending groups.
When it released its earnings in late April, FRB said it lost a significant amount of deposits in the first quarter, dooming its ability to remain independent.
Shortly thereafter, with the assistance of the FDIC, JPMorgan Chase (JPM) announced on May 1 that it will purchase the deposits and most assets of First Republic. FRB’s failure is now the second-largest failure in U.S. banking history.
How does this compare to the 2008 financial crisis? It doesn’t.
The 2008 crisis was sparked by ultra-easy mortgage lending practices that encouraged borrowers to buy homes they couldn’t afford and take out mortgages they didn’t understand.
While Signature Bank was heavy in the crypto space, the common thread in the 2023 failures was a bad bet on interest rates, not poor-quality assets.
FRB leaned heavily into jumbo-sized mortgages when rates were much lower. Silicon Valley loaded up on long-term Treasury bonds when yields were at rock-bottom levels.
When interest rates rose, those assets fell sharply in value, leading to their demise.
The decision by the FDIC to fully back the deposits of SVB and SB probably prevented a series of bank runs on mid-sized regional banks, which would have greatly increased the size and scope of the crisis.
Moreover, the Federal Reserve implemented a new lending facility to allow banks to borrow using high-quality assets as collateral, which helped shore up liquidity and calm frazzled nerves.
It’s not that these banks were experiencing the kind of troubles we saw in 2008, but the fear of a panic was real for those who had deposits that exceeded the FDIC limit.
It only takes a few keystrokes on a PC or smartphone to move cash today. Welcome to the world of 21st century bank runs.
We can’t definitively say there aren’t problems still lurking in the shadows. But JPMorgan CEO Jamie Dimon said, “This part of the crisis is over. For now, let’s take a deep breath.”
|Key Index Returns|
|Index||MTD %||YTD %|
|Dow Jones Industrial Average||2.5||2.9|
|S&P 500 Index||1.5||8.6|
|Russell 2000 Index||-1.9||0.4|
|MSCI World ex-U.S.A*||2.5||9.9|
|MSCI Emerging Markets*||-1.3||2.2|
|Bloomberg Barclays U.S. Aggregate Bond TR USD||0.6||3.6|
Source: Wall Street Journal, MSCI.com, MarketWatch, Bloomberg
MTD returns: March 31, 2023–April 28, 2023 YTD returns: December 30, 2022–April 28, 2023
With the banking crisis sliding to the back burner last month, investors turned to the economic fundamentals.
Inflation is gradually moderating, but it’s not yet on a path back to the Fed’s 2% annual target, something Fed Chief Powell and most Fed officials last year said was a prerequisite before ending its rate-hike campaign.
But banking jitters have forced the Fed to reevaluate the tools (rate hikes) they are using to rein in inflation. We may get a rate hike at the May 3 meeting. Perhaps this might be the last time this cycle.
But the Fed will keep its options open.
Talk of a pause aided shares in April. Better-than-expected corporate profits, according to Refinitiv, also supported stocks, offsetting economic concerns.
Still, economic storm clouds on the horizon likely limited gains last month.
“Usually, recessions sneak up on us. CEOs never talk about recessions,” economist Mark Zandi of Moody’s Analytics said late last year. “Now it seems CEOs are falling over themselves to say we’re falling into a recession. … Every person on T.V. says recession. Every economist says recession. I’ve never seen anything like it.”
Even the Federal Reserve, which rarely talks recession in advance, expects a mild recession to develop later in the year.
Given recent market action last month, investors aren’t yet betting on a recession.
Debt ceiling drama
The U.S. Treasury is running up against its ability to borrow to finance government spending, possibly as soon as early June.
Without an increase, the U.S. risks default. Republicans and Democrats are far apart, but a default is almost unthinkable. We believe a compromise will be reached that raises the debt ceiling, since the failure to do so would lead to catastrophic consequences for financial markets and the economy.
I trust you’ve found this review to be educational. If you have any questions or would like to discuss any matters, please feel free to give me or any of my team a call.