Traders weigh outlook for rates after bank collapse
U.S. regulators came to the rescue of Silicon Valley Bank depositors late Sunday, triggering a modest relief rally in stock-index futures.
But investors were left to weigh the outlook for Federal Reserve rate increases after the central bank’s aggressive tightening was flagged by economists and analysts for setting the stage for the second-largest bank failure in U.S. history.
Federal regulators said depositors at Silicon Valley Bank, or SVB, would have access to all deposits on Monday morning. That includes uninsured deposits — those exceeding the FDIC’s $250,000 cap — in a move that analysts said would help avert runs similar to the event that capsized SVB from occurring elsewhere. SVB SIVB, -60.41% stock and bondholders, however, will be wiped out.
Regulators said New York’s Signature Bank was also closed on Sunday and that its depositors would also be made whole.
The Fed also announced a new emergency loan program that it said would help assure banks have the ability to meet the needs of all their depositors.
“The American people and American businesses can have confidence that their bank deposits will be there when they need them,” President Joe Biden said in a statement Sunday night. “I am firmly committed to holding those responsible for this mess fully accountable and to continuing our efforts to strengthen oversight and regulation of larger banks so that we are not in this position again,” he said, adding that he will deliver additional comments Monday.
A deal that spared depositors would be expected to let stocks “rally strongly,” said Barry Knapp, managing partner and director of research at Ironsides Macroeconomics, in a phone interview ahead of the announcement Sunday afternoon. Conversely, measures that would have forced depositors to take a hit would have had the potential to spark an ugly reaction, he said.
Futures on the Dow Jones Industrial Average YM00, 1.24% rose 240 points, or 0.8% following the announcement, while S&P 500 futures ES00, 1.73% were up 1% and Nasdaq-100 futures NQ00, 1.71% gained 1.3%.
Investors will also be assessing the fallout to see if it complicates the Federal Reserve’s plans to hike interest rates further and potentially faster than previously expected in its bid to tamp down inflation.
SVB was closed by California regulators on Friday and taken over by the Federal Deposit Insurance Corp. Regulators raced over the weekend to come to a resolution for depositors after uncertainty around SVB triggered a sharp market selloff late last week.
“In what is an already jittery market, the emotional response to a failed bank reawakens our collective muscle memory of the GFC,” Art Hogan, chief market strategist at B. Riley Financial Wealth, told MarketWatch in an email, referring to the 2007-2009 financial crisis. “When the dust settles, we will likely find that SVB is not a ‘systematic’ issue.”
In a statement Sunday, Securities and Exchange Commission Chair Gary Gensler warned that regulators are on the lookout for misconduct: “In times of increased volatility and uncertainty, we at the SEC are particularly focused on monitoring for market stability and identifying and prosecuting any form of misconduct that might threaten investors, capital formation, or the markets more broadly. Without speaking to any individual entity or person, we will investigate and bring enforcement actions if we find violations of the federal securities laws.”
Knapp said a deal that leaves depositors whole would lift the overall market and allow bank stocks, which got hammered last week, to “rip” higher “because they are cheap” and the banking system “as a whole…is in really good shape.”
Banking stocks dropped sharply Thursday, led by shares of regional institutions, and extended their losses Friday. The selloff in bank stocks pulled down the broader market, leaving the S&P 500 SPX, -1.45% down 4.6%, nearly wiping out the large-cap benchmark’s early 2023 gains. The Dow DJIA, -1.07% saw a 4.6% weekly fall, while the Nasdaq Composite COMP, -1.76% declined 4.7%.
Investors sold stocks but piled into safe-haven U.S. Treasurys, prompting a sharp retreat in yields, which move opposite to prices.
SVB’s failure is being blamed on a mismatch between assets and liabilities. The bank catered to tech startups and venture-capital firms. Deposits grew rapidly and were placed in long-dated bonds, particularly government-backed mortgage securities. As the Federal Reserve began aggressively raising interest rates roughly a year ago, funding sources for tech startups dried up, putting pressure on deposits. At the same time, Fed rate hikes triggered a historic bond-market selloff, putting a big dent in the value of SVB’s securities holdings.
SVB was forced to sell a large chunk of those holdings at a loss to meet withdrawals, leading it to plan a dilutive share offering that stoked a further run on deposits and ultimately led to its collapse.
Meanwhile, the Fed’s newly announced Bank Term Lending Program will make loans of up to 12 months to banks and other depository institutions. In a crucial twist, it will allow the assets used as collateral for those loans to be valued at par, or face value, rather than marked to market. The Fed will also accept collateral at its discount window on the same conditions.
“These are strong moves,” said Paul Ashworth, chief North America economist at Capital Economics, in a note.
By accepting collateral at par rather than marking to market means that banks that have accumulated more than $600 billion in unreazlied losses on held-to-maturity Treasury and mortgage-backed securities portfolios and had failed to hedge interest-rate risk should be able to survive, he said.
“Rationally, this should be enough to stop any contagion from spreading and taking down more banks, which can happen in the blink of an eye in the digital age,” Ashworth wrote. “But contagion has always been more about irrational fear, so we would stress that there is no guarantee this will work.”
Analysts and economists had largely dismissed the notion that SVB’s woes marked a systemic problem in the banking system. Instead, SVB appeared to be a “a rather special case of poor balance-sheet management, holding massive amounts of long-duration bonds funded by short-term liabilities,” said Erik F. Nielsen, group chief economics adviser at UniCredit Bank, in a Sunday note.
Mismanagement aside, the Fed’s rate hikes created an environment that set the stage for problems, analysts said. A deeply inverted yield curve, in which short-dated Treasury yields run sharply above longer-dated Treasurys, amplifies liability and asset mismatches.
The yield on the 2-year note early last week traded more than 100 basis points, or a full percentage point, above the 10-year for the first time since the early 1980s.
“Inverting the yield curve as deeply as they did…there’s going to be more accidents if they continue down that path,” Knapp said. “Push that thing to 150 basis points and see what happens. You’re going to have more blowups.”
Fed-funds futures traders last week moved to price in a more-than-70% chance of an outsize 50-basis-point, or half a percentage point, rise in the benchmark interest rate at the Fed’s March meeting after Chair Jerome Powell told lawmakers that rates would need to move higher than previously anticipated. Expectations swung back to a 25-basis-point, or quarter-point move, as the SVB collapse unfolded, with traders also scaling back expectations for when rates will likely peak.
Meanwhile, a flight to safety saw the yield on the 2-year Treasury note, which had earlier in the week topped 5% for the first time since 2007, end the week down 27.3 basis points at 4.586%.