March 13, 2023

The collapse of Silicon Valley Bank (SVB) and the steps that regulators are taking to stem contagion will likely dominate markets this week. Investors will also be watching the Federal Reserve to see if it slows the pace of interest rate hikes in the wake of recent events.

In a bid to contain the spillover, U.S. financial regulators moved over the weekend to protect depositors’ funds at SVB and set up a new financial backstop. The aim is to strengthen confidence in the banking system and to stem concern that consumers and businesses would withdraw funds from smaller lenders.

The most important news over the weekend on the regulatory front included :

• Regulators have closed Signature Bank, a crypto-focused financial institution in New York.
• Regulators have decided to protect all deposits at SVB, as well as Signature. They aim to make deposits available on Monday.
• A new Bank Term Lending Facility has been created for all banks.

Some of these steps are similar to those implemented during the 2008 financial crisis. However, we do not believe we are facing a banking crisis. The measures taken are proactive and protective of banks and depositors. 

How Did We Get Here?

SVB’s failure is attributed to a mismatch between assets and liabilities, and a lack of diversification both in its deposit base and in its fixed income portfolio. The bank catered specifically to tech startups and venture capital firms – some of which have been forced to draw down deposits after other sources of funding dried up during last year’s market volatility.  

At the same time, Fed rate hikes triggered a historic bond market selloff last year, which eroded the value of SVB’s fixed income securities holdings. It then had to choose between keeping the securities and financing them with increasingly costly deposits and borrowings, or selling them at a loss and raising capital to offset the loss. Management, after continually messaging that they would hold the securities, abruptly changed course and decided to sell the securities and raise equity. Last week’s announcement of the loss and capital raise triggered a deposit run and subsequent FDIC takeover of the bank. 

What Does It Mean For Markets?

The combination of SVB’s collapse, Federal Reserve Chairman Jerome Powell’s hawkish comments to Congress and stronger-than-expected payrolls sent the S&P 500 down 4.6% last week, nearly wiping out its 2023 gains. The Dow Jones Industrial Average fell 4.4%, the tech-heavy Nasdaq Composite lost 4.7% and the small cap Russell 2000 plunged 8.1%.
 

The fixed income market was also volatile, with yields moving higher early last week after markets repriced in a greater likelihood of a 50-basis point hike at the Fed’s March meeting. Yields then retraced lower as investors sought the safety of U.S. Treasury bonds. After the two-year note pierced 5%, it fell to finish last week at 4.59%. The 10-year Treasury note yield declined 25-basis points to close at 3.69%.
 

S&P futures were indicating a lower opening on Monday morning, as the market digests the latest regulatory measures. Key CPI data will also remain in focus to determine if inflation remains as persistent as it was in January. Both will influence the Fed’s monetary policy plans.
 

For now, the Fed’s immediate focus will be on ensuring stability in the financial system. This raises the possibility it may not increase rates in March. The central bank may slow its rate hikes going forward to give it more time to assess the lagged effects of its policy. 

What Does It Mean For Investors?

While it is too soon to tell what the fallout will be, investors should take comfort from the fact that the U.S. banking system in general is significantly stronger following the 2008 Global Financial Crisis. The U.S.’s largest banks, including BNY Mellon, undergo annual financial stress tests to ensure they can withstand exogenous events. Rating agencies rank BNY Mellon among the highest rated of all global financial institutions.

The SVB failure does not change our economic outlook for a mild recession later this year or early 2024. However, it adds to the monetary policy uncertainty that has increased in the past few months, as the economy and consumers remain resilient to higher rates.

Our portfolios are positioned for volatility. Our neutral weightings in equities and fixed income, as well as a small overweight to diversifiers, helps protect principal, but it also allows us to move quickly when market volatility causes price dislocations. 

Please watch the replay of our special webcast where Leo Grohowski, Chief Investment Officer, and a panel of experts discuss latest developments and answer client questions.

Footnotes

¹ Board of Governors of the Federal Reserve System. Press Release, March 12, 2023.

 ² Bloomberg, March 12, 2023. “Signature Bank Closed by New York Regulators in SVB’s Wake”