The collapse of Silicon Valley Bank and Signature Bank has sent a shock wave across markets while sharply bolstering investor expectations that the Federal Reserve will ease up on the pace of its rate hikes—or stop raising interest rates entirely.
A week ago, before Silicon Valley Bank (SVB) became a household name as regulators ordered it shut and the Federal Deposit Insurance Corporation (FDIC) rushed in and vowed not to let depositors lose any money in the collapse, markets were expecting a zero percent chance that the Federal Reserve would leave rates unchanged at its upcoming policy meeting.
But the lightning-fast failure of SVB last week, along with the collapse of Signature Bank over the weekend, rejigged those calculations sharply as investors bet that the Fed would see the emergence of banking sector stress as a reason to ease up.
For a period of time on Monday, as markets digested the latest news on the bank failures and the government response to them, the odds that the Fed would hit pause were running above 30 percent.
“There’s been a radical change in interest rate expectations,” said Niels Christensen, chief analyst at Nordea. “The reason we’re seeing such repricing in rate hike expectations is the collapse of the banks.”
Goldman Sachs strategists said in a note Monday that “in light of recent stress in the banking system,” they no longer expect the Fed to deliver a rate hike on March 22 and that the future path of rates is now under a shroud of “considerable uncertainty.”
A week ago, the odds that the Fed would deliver a bigger 50 basis point hike were 31.4 percent. Currently, that probability has fallen to zero.
Christensen said that if the ripples from the twin bank failures fade and there’s no financial contagion, investor expectations for further rate hikes will resume.
“If we don’t see any spreading, expectations for rate hikes should be revived quickly,” he said.
Currently, most investors expect the Fed to raise rates by 25 basis points at the upcoming policy meeting, with the odds of that outcome now at 89.3 percent. That’s up from around 68.6 percent a week ago.
The Fed has raised rates quickly in the face of high inflation, though with limited impacts as price pressures have remained stubbornly elevated.
“We have a big data print tomorrow with CPI [inflation] and unless market turmoil really continues and leads to a tightening in financial conditions, then the Fed will do 25 bps,” said Mark Dowding, chief investment officer at BlueBay Asset Management.
“If rate hikes are starting to bite then you do have to proceed with more caution.”
‘Our Banking System Is Safe’
SVB’s failure came after it took a $1.8 billion loss on a forced $21 billion bond liquidation on Wednesday and then announced it was looking to raise $2.25 billion in capital to fill the balance sheet hole. The news spooked depositors and as they rushed to withdraw their money in a classic bank run, SVB stock plunged.U.S. financial authorities worked on several fronts to stem any potential fallout from the twin bank failures, which sparked fears of bank runs and contagion that could threaten broader financial system stability.
The Federal Reserve, the Treasury Department, and the FDIC jointly stepped in to help calm the nerves of frazzled investors.
The FDIC, which has been appointed receiver of SVB and set up a bridge bank to store the bank’s assets securely as it looks for a buyer to give its business a new lease on life, waived its $250,000 deposit insurance coverage limit to ensure all SVB’s depositors get all their money back.
The Fed set up an emergency liquidity mechanism, offering banks and other financial institutions an opportunity to borrow under easier terms than it normally provides.
Treasury provided a $25 billion emergency funding backstop for the Fed’s special lending tool in case demand is so high that it runs out of funds and needs to be topped up.
In a further bid to calm markets, President Joe Biden addressed the matter on Monday, saying that all SVB and Signature Bank customers, including small businesses, wouldn’t lose any money in the twin failures.
“The bottom line is this: Americans can rest assured that our banking system is safe,” Biden said.
Shareholders and bondholders stand to lose money as financial authorities wind the banks down but depositors will be made whole, Biden pledged.
“No losses will be borne by the taxpayers,” Biden added, noting that the money to cover depositors will come from insurance premiums that the FBIC levies on banks and other covered financial institutions.
Moral Hazard?
While some market participants said the moves by U.S. financial authorities should bolster market sentiment in the short-term, they risked eroding market discipline over the longer-term and could encourage riskier investments.Rabobank strategists Michael Every and Ben Picton argued in a note that the Fed’s emergency lending facility amounts to “allowing a massive easing of financial conditions as well as soaring moral hazard.”
Moral hazard is the removal of peoples’ incentive to guard against financial risk, encouraging market players to make riskier bets.
“More banks will likely fail despite the intervention, but we now have a clear roadmap for how the gov’t will manage them,” he added.
Ackman insisted that the emergency measures—the effective waiving of the $250,000 deposit coverage cap and the emergency liquidity mechanism—was “not a bailout in any form” as taxpayers wouldn’t be on the hook while investors and bondholders who didn’t “adequately oversee” the failed banks would be wiped out.
He added that the moves bolster confidence in the banking sector and reduce the likelihood of runs on America’s handful of “too big to fail” banks that would have put the burden of bailouts on taxpayers.
Economist Peter Schiff disagreed with this take, arguing in a Twitter post that this “absolutely is a bailout” and that taxpayers will “get the bill in the form of higher inflation.”
