Strategy blog: Banking stress containable

Risk-off prevailed in global capital markets towards the end of last week as concerns over the health of the US bank system moved into focus, following the collapse of Silicon Valley Bank (SVB). The bank suffered from a combination of idiosyncratic headwinds – high deposit withdrawal rates, a slowdown in funding and a concentrated (venture capital) customer base – compounded by losses on its treasury and mortgage-backed security portfolio. Its large investment portfolio was particularly exposed to longer-dated bonds, with little hedging to protect against rising policy rates.

We are, of course, watching the situation very closely for signs of contagion, which could threaten a wider contraction in credit and liquidity.

Policymakers have been quick to act. The US Treasury, Federal Reserve (Fed) and FDIC announced that they would fully protect all depositors with SVB – even those that were uninsured (but there are no plans for a wider bailout of shareholders and bondholders).

Moreover, the Fed announced that it would provide liquidity on demand to 'eligible depository institutions': the creation of a new Bank Term Funding Program (BTFP) offers loans of up to one year in length, with Treasuries/mortgage-backed securities as collateral. Importantly, the collateral will be valued at par, rather than mark-to-market, inflating the value of those assets relative to market value.

Of course, some contagion is inevitable. The highly-exposed Signature Bank – a key intermediary in the crypto space – has also closed (though regulators have protected customers' deposits there as well), while First Republic's shares have continued to sink today.

Unsurprisingly, a flight to safety has prompted a rally in bond markets and market-implied policy rates have also shifted sharply lower: the latest pricing suggests that the Fed funds rate is no longer expected to exceed 5%, a reduction of roughly 1 percentage point. Financial stability – alongside price stability and full employment – remains one of the Fed's central tenets, the lender of last resort. While we don't yet think the Fed is likely to reverse policy rates, it would be contradictory to continue tightening policy rates on the one hand, while easing liquidity conditions on the other.

From a fundamental standpoint, major banks' balance sheets are far stronger and more liquid than they were during the last big financial crisis, and authorities have been quicker to react (SVB is not as systemically important as Lehman either). Bank stocks have been hit hard, but interbank spreads and major banks' credit default swaps have risen only modestly as yet.

Given the nature of the risk – and still-fresh memories of the Global Financial Crisis – further market nervousness and volatility is likely, but the injections of liquidity needed to put out this fire may not be that large, or have major economic consequences.

From a top-down perspective, we have been waiting for residual cyclical risk to be dispelled: that risk has now been refocused on earnings rather than interest rates, but it leaves us still waiting for clarity. However, we do not think an outright reduction in risk assets from current levels is appropriate.

Ready to begin your journey with us?

Past performance is not a guide to future performance and nothing in this blog constitutes advice. Although the information and data herein are obtained from sources believed to be reliable, no representation or warranty, expressed or implied, is or will be made and, save in the case of fraud, no responsibility or liability is or will be accepted by Rothschild & Co Wealth Management UK Limited as to or in relation to the fairness, accuracy or completeness of this document or the information forming the basis of this document or for any reliance placed on this document by any person whatsoever. In particular, no representation or warranty is given as to the achievement or reasonableness of any future projections, targets, estimates or forecasts contained in this document. Furthermore, all opinions and data used in this document are subject to change without prior notice.

Read more articles

  • Perspectives podcast: The last mile

    Market Perspective

    The Swiss National Bank's decision to reduce interest rates came as a surprise to the market. Join our Global Investment Strategists to decode central banks' moves, unravel oil market dynamics, and track gold and bitcoin prices.

  • A rebound in corporate earnings?

    Strategy Blog

    Earnings growth is rising in the United States, suggesting the market could have passed a turning point. Ahead of the release of first quarter earnings figures, we consider what this means for investors and examine how earnings expectations can be fallible.

  • Asset Management: Monthly Macro Insights - April 2024

    Market Commentary

    Recent data suggest that inflation could prove persistently high for some time and limit the room for central bank easing. Despite this high-for-long path for policy stances, investors remain convinced it will not prove sufficient to derail global growth.

  • Are oil prices pushing inflation higher?

    Strategy Blog

    Oil prices are up by a fifth since January, but should we be worried this will sustain higher inflation? We consider how demand may be firming up as the depressed manufacturing sector picks up, and the impact that could have on demand for raw inputs like oil.

  • Einblicke: Q2 - 2024 - Potenziell weiterer Aufwind in bestimmten Branchen


    In unseren aktuellen "Einblicken" werfen wir einen Blick auf das abgelaufene sowie das kommende Quartal. Wir zeigen zudem auf, wie sich die Vermögensverwaltung von Rothschild & Co Deutschland im derzeitigen Umfeld positioniert. Lesen Sie jetzt die Einschätzungen unserer Experten.

  • Stock market optimism prevails in March

    Monthly Market Summary

    Global equities continued their upswing, rising by 3.1% in March (USD terms), while government bonds were also up by 0.7% (USD, hedged terms).

Back to top