InvestMacro

By Vidhura S. Tennekoon, Indiana University 

Silicon Valley Bank and Signature Bank failed with enormous speed – so quickly that they could be textbook cases of classic bank runs, in which too many depositors withdraw their funds from a bank at the same time. The failures at SVB and Signature were two of the three biggest in U.S. banking history, following the collapse of Washington Mutual in 2008.

How could this happen when the banking industry has been sitting on record levels of excess reserves – or the amount of cash held beyond what regulators require?

While the most common type of risk faced by a commercial bank is a jump in loan defaults – known as credit risk – that’s not what is happening here. As an economist who has expertise in banking, I believe it boils down to two other big risks every lender faces: interest rate risk and liquidity risk.

Interest rate risk

A bank faces interest rate risk when the rates increase rapidly within a shorter period.

That’s exactly what has happened in the U.S. since March 2022. The Federal Reserve has been aggressively raising rates – 4.5 percentage points so far – in a bid to tame soaring inflation. As a result, the yield on debt has jumped at a commensurate rate.

The yield on one-year U.S. government Treasury notes hit a 17-year high of 5.25% in March 2023, up from less than 0.5% at the beginning of 2022. Yields on 30-year Treasurys have climbed almost 2 percentage points.

As yields on a security go up, its price goes down. And so such a rapid rise in rates in so short a time caused the market value of previously issued debt – whether corporate bonds or government Treasury bills – to plunge, especially for longer-dated debt.

For example, a 2 percentage point gain in a 30-year bond’s yield can cause its market value to plunge by around 32%.

SVB, as Silicon Valley Bank is known, had a massive share of its assets – 55% – invested in fixed-income securities, such as U.S. government bonds.

Of course, interest rate risk leading to a drop in market value of a security is not a huge problem as long as the owner can hold onto it until maturity, at which point it can collect its original face value without realizing any loss. The unrealized loss stays hidden on the bank’s balance sheet and disappears over time.

But if the owner has to sell the security before its maturity at a time when the market value is lower than face value, the unrealized loss becomes an actual loss.

That’s exactly what SVB had to do earlier this year as its customers, dealing with their own cash shortfalls, began withdrawing their deposits – while even higher interest rates were expected.

This bring us to liquidity risk.

Liquidity risk

Liquidity risk is the risk that a bank won’t be able to meet its obligations when they come due without incurring losses.

For example, if you spend US$150,000 of your savings to buy a house and down the road you need some or all of that money to deal with another emergency, you’re experiencing a consequence of liquidity risk. A large chunk of your money is now tied up in the house, which is not easily exchangeable for cash.

Customers of SVB were withdrawing their deposits beyond what it could pay using its cash reserves, and so to help meet its obligations the bank decided to sell $21 billion of its securities portfolio at a loss of $1.8 billion. The drain on equity capital led the lender to try to raise over $2 billion in new capital.

The call to raise equity sent shockwaves to SVB’s customers, who were losing confidence in the bank and rushed to withdraw cash. A bank run like this can cause even a healthy bank to go bankrupt in a matter days, especially now in the digital age.

In part this is because many of SVB’s customers had deposits well above the $250,000 insured by the Federal Deposit Insurance Corp. – and so they knew their money might not be safe if the bank were to fail. Roughly 88% of deposits at SVB were uninsured.

Signature faced a similar problem, as SVB’s collapse prompted many of its customers to withdraw their deposits out of a similar concern over liquidity risk. About 90% of its deposits were uninsured.

Systemic risk?

All banks face interest rate risk today on some of their holdings because of the Fed’s rate-hiking campaign.

This has resulted in $620 billion in unrealized losses on bank balance sheets as of December 2022.

But most banks are unlikely to have significant liquidity risk.

While SVB and Signature were complying with regulatory requirements, the composition of their assets was not in line with industry averages.

Signature had just over 5% of its assets in cash and SVB had 7%, compared with the industry average of 13%. In addition, SVB’s 55% of assets in fixed-income securities compares with the industry average of 24%.

The U.S. government’s decision to backstop all deposits of SVB and Signature regardless of their size should make it less likely that banks with less cash and more securities on their books will face a liquidity shortfall because of massive withdrawals driven by sudden panic.

However, with over $1 trillion of bank deposits currently uninsured, I believe that the banking crisis is far from over.

About the Author:

Vidhura S. Tennekoon, Assistant Professor of Economics, Indiana University

This article is republished from The Conversation under a Creative Commons license. Read the original article.

By George Prior

The Federal Reserve faces its biggest dilemma yet as mistakes from the past come back to haunt, warns the CEO of one of the world’s largest independent financial advisory, asset management and fintech organizations.

The stark warning from deVere Group’s Nigel Green comes as US CPI data published yesterday reveals that core inflation rose in February in the world’s largest economy.

He says: “The headline CPI last month had risen by 6% from last year, down from the 6.4% pace recorded in January, as expected.

“However, core inflation which takes out volatile elements such as food and energy prices, jumped 0.5% on the month, and 5.5% on the year.

“This presents the biggest dilemma yet for the Fed.”

Nigel Green continues: “The central bank has the unenviable task of trying to cool high inflation – which remains stubbornly high and with core inflation on the rise again – despite one of the most aggressive rate hike programs in the world, as well as maintaining financial stability, in the face of the second and third biggest bank failures in US history in recent days.

“It’s time for an honest conversation. The Fed has already spectacularly failed to control inflation so far.

“Now they need to roll higher rates to cool inflation, but these pumped-up rates could trigger yet more problems for the critical banking sector.

“Investors are increasingly concerned that the Fed’s overtightening now – when monetary policy time lags are notoriously long – could steer the US economy into a recession.”

Time lag in monetary policies is very high. Economists estimate interest rate changes take up to 18 months to have the full effect. This means monetary policymakers need to try and predict the state of the economy 18 months ahead.

“We expect the central bank will remain hawkish. They will argue there’s not enough evidence to revise the hikes.”

The deVere CEO says “mistakes from the past come back to haunt” the Federal Reserve.

“The Fed didn’t act quickly enough to tame inflation. They resisted raising interest rates from near-zero levels for most of 2021, even as prices began shooting up due to pandemic-related supply chain snarls, Covid outbreaks and a persistent labour shortage, amongst other issues,” he notes. “This all leads to sky-high inflation – and especially wage inflation.”

It would seem that the Fed hasn’t learned the lessons from the 1980s.

“During much of the 1970s, the US central bank refused to roll-out rate hikes, probably due to political pressure from leaders unwilling to allow higher unemployment on their watch.

“Of course, this made workers keep asking for ever higher salaries, which forced businesses to keep increasing prices to compensate, and which led to the infamous 1980’s wage-price spiral and the recession.”

The deVere chief also flags not bringing quantitative easing (QE) to an end sooner as another potential mistake made by the Fed.

In 2022, the Fed brought an end to its QE policy, involving purchases of Treasury and mortgage-backed securities. QE was aimed at providing more liquidity to capital markets.

“Could QE have helped spur inflation as the increased money supply resulted in too much money chasing too few goods and services at that time?” he asks.

Nigel Green concludes: “Mistakes of the past are coming back to haunt the Fed as they face their toughest decision yet at their next meeting on March 22.”

About:

deVere Group is one of the world’s largest independent advisors of specialist global financial solutions to international, local mass affluent, and high-net-worth clients.  It has a network of offices across the world, over 80,000 clients and $12bn under advisement.

By Christopher Decker, University of Nebraska Omaha 

The Federal Reserve is facing a rather sticky problem. Despite its best efforts over the past year, inflation is stubbornly refusing to head south with any urgency to a target of 2%.

Rather, the inflation report released on March 14, 2023, shows consumer prices rose 0.4% in February, meaning the year-over-year increase is now at 6% – which is only a little lower than in January.

So, what do you do if you are a member of the rate-setting Federal Open Market Committee meeting March 21-22 to set the U.S. economy’s interest rates?

The inclination based on the Consumer Price Index data alone may be to go for broke and aggressively raise rates in a bid to tame the inflationary beast. But while the inflation report may be the last major data release before the rate-setting meeting, it is far from being the only information that central bankers will be chewing over.

And economic news from elsewhere – along with jitters from a market already rather spooked by two recent bank failures – may steady the Fed’s hand. In short, monetary policymakers may opt to go with what the market has already seemingly factored in: an increase of 0.25-0.5 percentage point.

Here’s why.

While it is true that inflation is proving remarkably stubborn – and a robust March job report may have put further pressure on the Fed – digging into the latest CPI data shows some signs that inflation is beginning to wane.

Energy prices fell 0.6% in February, after increasing 0.2% the month before. This is a good indication that fuel prices are not out of control despite the twin pressures of extreme weather in the U.S. and the ongoing war in Ukraine. Food prices in February continued to climb, by 0.4% – but here, again, there were glimmers of good news in that meat, fish and egg prices had softened.

Although the latest consumer price report isn’t entirely what the Fed would have wanted to read – it does underline just how difficult the battle against inflation is – there doesn’t appear to be enough in it to warrant an aggressive hike in rates. Certainly it might be seen as risky to move to a benchmark higher than what the market has already factored in. So, I think a quarter point increase is the most likely scenario when Fed rate-setters meet later this month – but certainly no more than a half point hike at most.

This is especially true given that there are signs that the U.S. economy is softening. The latest Bureau of Labor Statistics’ Job Openings and Labor Turnover survey indicates that fewer businesses are looking as aggressively for labor as they once were. In addition, there have been some major rounds of layoffs in the tech sector. Housing has also slowed amid rising mortgage rates and falling prices. And then there was the collapse of Silicon Valley Bank and Signature Bank – caused in part by the Fed’s repeated hikes in its base rate.

This all points to “caution” being the watchword when it comes to the next interest rate decision. The market has priced in a moderate increase in the Fed’s benchmark rate; anything too aggressive has the potential to come as a shock and send stock markets tumbling.

About the Author:

Christopher Decker, Professor of Economics, University of Nebraska Omaha

This article is republished from The Conversation under a Creative Commons license. Read the original article.

By JustMarkets

Inflationary pressures in the United States are easing. The latest data showed that consumer prices fell from 6.4% to 6.0% year-over-year. Core inflation (which excludes food and energy prices) has declined from 5.6% to 5.5%. This raises the possibility of a small interest rate hike by the Federal Reserve next week. As the stock market closed on Tuesday, the Dow Jones Index (US30) increased by 1.06%, and the S&P 500 Index (US500) added 1.65%. The NASDAQ Technology Index (US100) gained 2.14% yesterday.

According to the CME FedWatch tool, most futures traders expect a quarter-point hike next week, though 31% of traders are betting that the Fed will hold off on raising rates.

After the Silicon Valley Bank collapse, a wave of customers applied to transfer their accounts to major US banks such as JPMorgan Chase & Co (JPM) and Citigroup Inc (C). The US government’s emergency measures to prevent the collapse of regional banks have not stopped depositors from trying to transfer their accounts to larger banks. Thus, regional banks may suffer even more in the coming days and weeks.

Equity markets in Europe rose yesterday. German DAX (DE30) jumped by 1.83%, French CAC 40 (FR40) gained 1.86%, Spanish IBEX 35 (ES35) added 2.19%, and British FTSE 100 (UK100) closed up by 1.17%.

European bond yields fell further as investors bet on the European Central Bank’s (ECB) easing of policy tightening. Traders are now estimating a 25 basis point increase as the most likely outcome of this Thursday’s ECB policy meeting. But the latest inflation data is not conducive to that. Spain’s annualized inflation rate rose from 5.9% to 6.0%. Meanwhile, core inflation (which excludes food and energy prices) also added 0.1% last month. The data point to sustained inflationary pressures. A number of other European countries will release consumer price data this week, followed by the overall figure for the Eurozone on Friday.

Portugal announced a rash of measures Thursday to address the housing crisis, including ending the Golden Visa scheme and banning new Airbnb licenses for short-term rentals. Rents and housing prices have risen sharply in Portugal, which is one of the poorest countries in Western Europe. Last year, more than 50% of workers earned less than 1,000 euros a month, while rents in Lisbon alone jumped by 37% in 2022. To solve the housing shortage, the government will rent vacant homes directly from landlords for five years and put them on the rental market.

Oil fell to a three-month low due to concerns about inflation and US bank closures. It was the biggest one-day percentage decline since early January. Moreover, both contracts also fell into a technical oversold zone for the first time in weeks.

Asian markets were mostly down yesterday. Japan’s Nikkei 225 (JP225) decreased by 2.16%, China’s FTSE China A50 (CHA50) fell by 0.64%, Hong Kong’s Hang Seng (HK50) ended the day down by 2.27%, India’s NIFTY 50 (IND50) fell by 0.65%, and Australia’s S&P/ASX 200 (AU200) ended Tuesday down by 1.41%.

In China, the latest economic data showed that industrial production rose by 2.4% last month (expectation of 2.6%). The improvement in production from the previous month indicates that industrial activity is still recovering after the country’s zero COVID policy was lifted. Retail sales also rose, indicating that consumer spending is also on the road to recovery. Fixed-asset investment rose by 5.5% in February (expected 4.4%). This indicates that businesses are investing heavily in anticipation of an economic recovery this year. The unemployment rate rose slightly, from 5.5% to 5.6%. Overall, the economic data showed that the country’s recovery is gaining momentum, but not at an even pace.

The minutes of the Bank of Japan’s monetary policy meeting showed that it is important to continue easing monetary policy. The BoJ expects the economy to recover this year, and inflation is likely to slow down by the last half of the next fiscal year.

New Zealand’s balance of payments deficit reached its highest level in 34 years. The deficit between what the economy earns and what it spends reached $33.8 billion for the year, a record 8.9% of GDP. The increase in the deficit is mainly due to increased imports of goods and services. The size of the balance of payments deficit matters to the rating agencies, which could downgrade New Zealand by making borrowing more expensive if there are fears that the situation will get out of hand.

S&P 500 (F) (US500) 3,919.29 +63.53 (+1.65%)

Dow Jones (US30)32,155.40 +336.26 (+1.06%)

DAX (DE40) 15,232.83 +273.36 (+1.83%)

FTSE 100 (UK100) 7,637.11 +88.48 (1.17%)

USD Index 103.67 +0.08 +0.08%)

• – Japan BoJ Monetary Policy Meeting Minutes at 01:50 (GMT+2);
• – China Retail Sales (m/m) at 04:00 (GMT+2);
• – China Industrial Production (m/m) at 04:00 (GMT+2);
• – China Unemployment Rate (m/m) at 04:00 (GMT+2);
• – French Consumer Price Index (m/m) at 12:00 (GMT+2);
• – Eurozone Industrial Production (m/m) at 12:00 (GMT+2);
• – UK Annual Budget Release at 14:30 (GMT+2);
• – US Producer Price Index (m/m) at 14:30 (GMT+2);
• – US Retail Sales (m/m) at 14:30 (GMT+2);
• – US NY Empire State Manufacturing Index (m/m) at 14:30 (GMT+2);
• – US Crude Oil Reserves (w/w) at 16:30 (GMT+2);
• – New Zealand GDP (q/q) at 23:45 (GMT+2).

By JustMarkets

This article reflects a personal opinion and should not be interpreted as an investment advice, and/or offer, and/or a persistent request for carrying out financial transactions, and/or a guarantee, and/or a forecast of future events.

By George Prior

Quick take by Nigel Green, CEO and founder of deVere Group, one of the world’s largest independent financial advisory, asset management and fintech organisations:

“US inflation slows to a 6% annual rate, which came in as expected, and represents the slowest annual increase in consumer prices since September 2021.

“Whilst prices in February were 6% higher than a year ago, they are down from an annual rate of 6.4% in January and considerably lower than the 9.1% peak of inflation experienced in June 2022.

“This slowdown is a win for the Federal Reserve, which has been fighting an uphill battle to try and cool red hot inflation.

“The 6% headline figure is positive, and together with the collapse of Silicon Valley Bank and Signature Bank, the second and third biggest bank failures in US history, will certainly give the Fed cause to reconsider their rate hiking agenda.

“However, against a backdrop of a robust labor market, we still expect the central bank will raise interest rates by a quarter-point at their next meeting on March 22.

“Should the Fed pause the rate hike agenda now, it puts them at risk of exposing themselves to inflation speeding up again. And then they would be forced to make larger hikes later, which would harm their objective and dent their credibility, so they can be expected to err on the side of caution.As such, it is likely that they will hike rates, albeit by a quarter-point.

“But due to the time-lag associated with CPI data, we would champion a move by the Fed not to raise rates at all later this month.”

About:

deVere Group is one of the world’s largest independent advisors of specialist global financial solutions to international, local mass affluent, and high-net-worth clients.  It has a network of offices across the world, over 80,000 clients and $12bn under advisement.

By JustMarkets

The Federal Reserve will lend one year’s worth of securities portfolios to banks under a new term financing program for banks, eliminating the risk that banks could be forced to sell their $4.4 trillion in government securities at a loss. Meanwhile, the Federal Deposit Insurance Corporation (FDIC) will safeguard all depositors of SVB, as well as depositors of Signature Bank of New York, closed by New York State because of “systemic risk.” According to politicians, these actions will reduce the burden on the financial system and support financial stability. Thus, US authorities are trying to avoid the risks of the 2008 crisis. But for investors and hedge funds, such actions were not so convincing. By the close of the stock market on Monday, Dow Jones (US30) decreased by 0.28%, S&P 500 (US500) lost 0.15%. The NASDAQ Technology Index (US100) gained 0.45% yesterday.

Considering the last news, Goldman Sachs no longer expects the Fed to raise rates at next week’s meeting. The bank sees “significant uncertainty about the path beyond March.” Concerns about financial stability are so great that investors speculate that the Fed now won’t want to rock the boat by raising interest rates by a whopping 50 basis points next week and may not raise them at all. The implied peak in rates has dropped to 5.08% from 5.69%. Many funds now assume the FOMC will raise rates by 25 bps in May, June, and July.

Equity markets in Europe showed their biggest one-day drop of the year yesterday. German DAX (DE30) fell by 3.04%, French CAC 40 (FR40) lost 2.90%, Spanish IBEX 35 (ES35) decreased by 3.51%, and British FTSE 100 (UK100) closed down by 2.58%. The STOXX 600 pan-European index closed the day down by 2.3%, with bank, financial, insurance, and energy stocks taking the brunt of the sellers’ pressure. European bank stocks fell by 5.7%. Investors were shaken by the events of the last few days, so such sell-offs are quite an expected reaction.

HSBC agreed with the Bank of England to buy the British operations of Silicon Valley Bank. After the news, HSBC shares fell by 4.1% by the end of the day. German Commerzbank fell by 12.7%, and French Societe Generale and Spanish Sabadell fell by 6.2% and 11.4%, respectively. Analysts at Morgan Stanley note that the strong liquidity in the structure of the balance sheet of European banks will avoid forced closure or sale of portfolios of bonds.

The European Central Bank meets Thursday and is still expected to raise its rate by 50 basis points and mark further tightening, although it will now have to consider financial stability.

Oil prices fell more than 2% in volatile trading Monday as the Silicon Valley Bank collapse rattled stock markets and raised fears of a new financial crisis—short-term US. Treasury bond yields continued to fall Monday amid lingering fears about the aftermath of the Silicon Valley Bank collapse. Given that gold and silver are inversely correlated to government bond yields, this situation contributes to a sharp strengthening of the precious metals.

Asian markets traded yesterday without a single trend. Japan’s Nikkei 225 (JP225) declined by 1.11%, China’s FTSE China A50 (CHA50) gained 0.88%, Hong Kong’s Hang Seng (HK50) jumped by 1.95%, India’s NIFTY 50 (IND50) was 1.49% lower, while S&P/ASX 200 Australia (AU200) closed down by 0.50% on Monday. But since the market opened on Tuesday, Asian indices started to show sharp declines. Investors are sharply reducing their positions in banking stocks amid fears of contagion from the looming US crisis, and there is also growing uncertainty over monetary policy ahead of US inflation data (CPI). Any signs of overheated inflation combined with problems in the banking sector could be a bad omen for Asian stock markets.

S&P 500 (F) (US500) 3,855.76 −5.83 (−0.15%)

Dow Jones (US30)31,819.14 −90.50 (−0.28%)

DAX (DE40) 14,959.47 −468.50 (−3.04%)

FTSE 100 (UK100) 7,548.63 −199.72 (−2.58%)

USD Index 103.63 −0.95 (−0.90%)

• – UK Average Earnings Index (m/m) at 09:00 (GMT+2);
• – UK Claimant Count Change (m/m) at 09:00 (GMT+2);
• – UK Unemployment Rate (m/m) at 09:00 (GMT+2);
• – Switzerland Producer Price Index (m/m) at 09:30 (GMT+2);
• – Spanish Consumer Price Index (m/m) at 10:00 (GMT+2);
• – US Consumer Price Index (m/m) at 14:30 (GMT+2);
• – US FOMC Member Bowman Speaks at 23:20 (GMT+2).

By JustMarkets

This article reflects a personal opinion and should not be interpreted as an investment advice, and/or offer, and/or a persistent request for carrying out financial transactions, and/or a guarantee, and/or a forecast of future events.

By ForexTime

Article by ForexTime

ForexTime Ltd (FXTM) is an award winning international online forex broker regulated by CySEC 185/12 www.forextime.com