Bank crisis hammers Fed hike expectations

The Silicon Valley Bank (SVB) went bust on Friday, around 44 hours after announcing that they would raise capital to fill in an almost $2 billion hole, after the bank sold its loss-making portfolio, rich in US treasuries, to pay their depositors – who are mostly tech startups – back in the actual environment of rising interest rates.  

Signature Bank also collapsed abruptly this weekend, as regulators said that keeping the bank – which has a big real estate portfolio and law firms’ money, could threaten the stability of the entire financial system. 

SVB’s flash crash raised questions that other similar local banks in the US could also experience liquidity issues and may not be able to pay their depositors back, unless they also start selling their probably loss-making portfolios.  

So, the likes of First Republic Bank, PacWest Bancorp and Signature Bank suffered heavy losses on Friday.  

Across Europe, big banks pulled indices down on Friday, as well – even though they are not expected to have similar liquidity issues as the Silicon Valley Bank. Most big banks have a diversified client base and more importantly don’t have the same exposure to tech startups, which are extremely rate sensitive. 

The contagion risk remains for small banks with highly rate-sensitive clients, but the US authorities now step in to avoid contagion. They said that SVB depositors could access their money today. 

The bank crisis changes the landscape for Fed expectations

The bank crisis will be sitting in the headlines, as solutions and possible contagion beyond the banking sector and beyond the US borders will be on the menu of the week. 

The latter will likely interfere with Federal Reserve (Fed) rate hike expectations, as well, as the Fed may want to think twice before stepping on the gas this month; Mr. Powell certainly doesn’t want to go down in history as the clumsiest Fed President in the history of the Fed.  

So, it is well possible that the Fed may simply FORGET about a 50bp hike this month or may not hike at all.  

Activity in Fed funds futures now assesses more than 98% chance for a 25bp hike in March, not because the US jobs data was soft enough to overhaul rate hike expectations last Friday, but because the Fed can’t ignore the issues caused by the steep interest rate increases in the banking sector and can’t afford to trigger a financial crisis to bring inflation back to 2%.  

Economic data will be important, but the developments across the banking sector could overshadow the data.  

Last Friday, the US released a mixed jobs report. The NFP printed another strong 311’000 new nonfarm jobs additions in February, versus around 200’000 expected by analysts. But the unemployment rate ticked higher from 3.4% to 3.6%, as the participation rate improved, and the wages grew less than expected.  

The kneejerk market reaction was a swift decline in the US dollar, and the yields. But of course, a major part of the decline in the US short term yields is due to the expectations that the Fed may have its hands tied faced with the banking crisis and could forget about another rate hike in the immediate future.  

The latest fall in US yields is not necessarily based on the best foundation for a stock rally. And indeed we saw the S&P500 dive on Friday to the bearish consolidation zone below the major 38.2% Fibonacci retracement on the October to February rally. But at the time of writing, the S&P500 futures hint at an almost 2% rise at the open. 

Tomorrow, the US will release the latest inflation figures for February, and the expectation is a further decline both in headline and core inflation. A sufficient decline in US inflation will cement the idea of a 25bp hike, or no rate hike from the Fed this month. But even disappointing inflation figures may not fuel the Fed rate hike expectations, depending on how the situation evolves on the banks’ front.