SVB is a reminder that ‘things tend to break’ when Fed hikes rates aggressively
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Analysts played down the threat to the U.S. banking system after the collapse of a regional lender Friday, but the failure of Silicon Valley Bank served to underline longstanding worries that the Federal Reserve’s aggressive series of interest rate hikes will eventually cause something in the world’s financial plumbing to break.
And so, U.S. stocks closed sharply lower Friday, posting big weekly losses and nearly wiping out a year-to-date gain for the S&P 500
SPX,
Underscoring the worry, investors continued to pile into safe-haven U.S. Treasurys, pulling yields down sharply.
Investors tend to “shoot first and ask questions later,” noted Thomas Martin, senior portfolio manager at Atlanta-based GLOBALT Investments, in a phone interview.
California’s banking regulator shut down Silicon Valley Bank on Friday, with the Federal Deposit Insurance Corp. named as a receiver. Shares of bank parent SVB Financial Group
SIVB,
had plunged Thursday after it disclosed large losses from securities sales and announced a dilutive stock offering along with a profit warning.
Banking stocks dropped sharply Thursday, led by shares of regional institutions, and extended losses Friday. The selloff in bank stocks pulled down the broader market on Thursday and Friday, leaving the Dow Jones Industrial Average
DJIA,
down 4.4% for the week, whie the S&P 500 dropped 4.6% and the Nasdaq Composite
COMP,
declined 4.7%.
See: Bank ETFs fall amid concerns over SVB and ‘crack’ in financial system after rate hikes
How does the Fed figure into this?
The bank catered to tech clients, who acutely felt the pinch of rising interest rates as they dented valuations. Struggling for funding, they pulled money from the bank.
As a result, Silicon Valley Bank was forced to sell a large chunk of its bondholdings at a loss as it attempted to stay afloat. Those bondholdings suffered as a result of the Fed’s aggressive rate increases — ratcheting up the fed-funds rate from near zero to 4.5% to 4.75% in less than a year.
Those rate hikes led to a sharp rise in Treasury yields, which move opposite to price. Treasurys and other bonds suffered one of their worst years on record in 2022. That’s not necessarily a problem for banks that hold bonds to maturity. But it can be if they’re forced to sell, as was SVB.
Do SVB’s woes signal problems for other banks? Analysts at UBS noted no signs of stress in the interbank lending market. Bank analysts pointed to more diversified sources of deposit funding for other banks, arguing that “contagion” risk was limited.
The collapse of SVB spells trouble for tech startups and other companies who held deposits of more than $250,000 — the maximum amount insured by the FDIC.
See: Silicon Valley Bank is an ‘extinction level event’ for startups, says Y Combinator’s Garry Tan
Losses on hold-to-maturity securities at commercial banks are unlikely to become a systemic issue, said Paul Ashworth, chief North American economist at Capital Economics, in a Friday note. FDIC deposit insurance will prevent runs on most banks, while those that need to raise cash can use the Fed’s repo facility and discount window or take a Federal Home Loan Bank loan to avoid realizing losses. And most banks have presumably hedged their interest rate risk in the swaps market, he said.
Nevertheless, SVB’s troubles “are a timely reminder that when central banks throw their rate hammer around with abandon, things tend to break — if not in the real economy, then in the financial system,” Ashworth wrote.
Indeed, it’s less a question of “contagion” and more an issue of how immune banks are to funding pressures, said GLOBALT’s Martin. “Banks’ ability to manage that and get ahead of that is important,” he said, noting that SVB apparently failed to do so.
As for the Fed, it now has “has very clear evidence” that it is “having an impact on the financial system and the economy — rate hikes are starting to bite — and while that’s not enough to give them pause, it is something they will take into consideration,” said Mark Haefele, chief investment officer at UBS Global Wealth Management, in a Friday note.
Expectations for a half percentage point interest rate increase when Fed policy makers meet later this month were significantly scaled back after SVB’s woes rattled financial markets this week. Fed-funds futures indicated traders had seen a 70% or better chance of an outsize 50 basis point increase on March 22 early Thursday. By Friday afternoon, fed-funds futures indicated a 41% probability of a 50 basis point move and 59% chance of a 25 basis point increase.
See: Financial-system risks put a smaller March rate hike by Federal Reserve back in play
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