Markets have been incredibly volatile recently with the Federal Reserve stepping in to protect both insured and uninsured depositors of Silicon Valley Bank and Signature Bank last weekend. With a duty to safeguard the stability of the banking system, the Fed took action to ensure depositors are made whole under the Federal Deposit Insurance Corporation (FDIC) while also launching a new program The Bank Term Funding Program (BTFP). This program allows eligible banks to borrow against their underwater bond holdings as a way to address heightened liquidity pressure in the banking system while enhancing confidence among depositors in U.S. financial institutions.
With the memories of the Global Financial Crisis that peaked in 2008 still fresh in many investors’ minds, JNBA would like to share our view that the launch of the Fed’s backstop resembles a new form of Quantitative Easing which will likely be paramount in their effort to calm depositors and prevent additional runs on bank deposits. So far, this banking crisis has been treated as a liquidity issue, with the Fed offering banks access to capital for up to one year in exchange for using qualifying underwater bonds as collateral. This should help limit the risk of banking failures cascading into a broader financial crisis.
Following the Global Financial Crisis, our country’s largest banks (which hold the lion’s share of our nation’s deposits) appear to be well capitalized, incredibly liquid, and have a diverse customer base. In contrast, Silicon Valley Bank and Signature Bank had a very concentrated set of depositors who all rushed for the exit simultaneously, fueled by the speed with which panic can spread through social media and the ease with which online banking technology makes it possible to move funds with a few keystrokes. The fact that most of these customers were uninsured businesses contributed to fears which likely were felt among less informed consumers whose deposits were already covered under the $250,000 umbrella of the FDIC.
Additionally, the problems at Silicon Valley Bank and Signature Bank are quite different from what occurred during the Global Financial Crisis, when bad loans punched a massive hole in the asset side of bank balance sheets. This time around, it was less about banks being insolvent and more about their ability to provide liquidity to depositors due to their assets being tied up in longer-term debt instruments that were not adequately hedged for liquidity in the face of rising interest rates.
Before the takeovers of both banks, the Fed had largely reversed course by resetting market expectations for a possible reacceleration of interest rate hikes at its March 21-22 meeting to combat stubbornly high inflation. After all, one of the Fed’s two mandates is to ensure price stability. However, given the recent signals from the bond market, it appears the Fed may now need to slow down or even pause their rate hiking cycle to ensure that the fear of further banking problems is lessened.
In the view of the JNBA Investment Committee, recent headlines of weaker retail sales, rising layoff announcements, and a cooling off in wage growth appear to give the Fed some wiggle room to proceed at a slower pace given this latest development. Although the economy has proven resilient to rate hikes thus far, inflation still remains a bit problematic. The latest core price inflation data from earlier this week suggests the Fed could still have some work to do (excluding food and energy, inflation is rising 6% annualized – the fastest pace in five months – and goods deflation seems to be losing steam).
In the wake of this news, it seems likely for banks to pull back on lending to meet future withdrawal requests from depositors. If the FDIC must prepare to cover more uninsured deposits, funding costs for banks should rise and stricter lending standards might follow. Should the pace at which businesses can access capital slow, a softer jobs market could set the stage for rising credit spreads and a possible equity sell-off. What’s more, the yield curve has re-steepened at the fastest pace in 40 years as short-term bonds have rallied, suggesting the rate tightening cycle may be much closer to being finished and a recession on the horizon. If this causes the Fed to finish their rate hiking cycle, we could see a possible set up for a stock market to rally assuming the loss of trust in the financial system is not material. All that said, the future remains uncertain, especially when it pertains to crowd psychology. As such, the JNBA Investment Committee plans to remain skeptical and will proceed with caution in making any adjustments to client portfolios.
Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this blog serves as the receipt of, or as a substitute for, personalized investment advice from JNBA Financial Advisors, LLC.
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