Everyone, everywhere are almost certain that a rising US interest rate is inevitable, until a banking crisis exposed the risk that the US Federal Bank took when they raised interest rates too fast, too furious. This led to the failure of a slew of banks with Silicon Valley Bank (SVB) gracing the headlines of every news media site in the world and is the second largest bank failure in US since Washington Mutual during the 2008 financial crisis.
Over the past year, the Fed has been hiking interest rates at an aggressive, quick clip in an effort to tame high inflation in the United States. The common adage on Wall Street is that the Fed increases rates until something breaks. Until last week, the question was what, if anything, was breaking. Interest rate increases generally take some time to work their way through the economy, but some people were sort of scratching their heads at just how long that lag seemed to be. The job market, which interest rate increases are aimed at cooling, has remained strong. The economy is generally in surprisingly decent shape. Sure, things looked a little ugly in crypto and tech, but maybe the trouble would be contained there.
SVB’s downfall was the result of a bank run after signs of trouble at the bank began to emerge in the second week of March. The bank, which in SVB’s case caters largely to tech, startups, and venture capital, takes deposits from clients and invests them in generally safe securities, like bonds. As the Fed has increased interest rates, those bonds have become worth less. That wouldn’t normally be an issue as SVB would just wait for those bonds to mature. But because there’s been a slowdown in venture capital and tech more broadly, in part because there’s less free and cheap money floating around, deposit inflows slowed, and clients started withdrawing their money. It became clear SVB was in the midst of a cash crunch, which caused panic and ultimately took the bank under.
The downfall of SVB sounded alarm throughout the banking community as the biggest threat to its collapse, is not the money of the depositors, which is generally protected by the depositor's insurance scheme. The problem is that SVB held millions of dollars of cash of healthy technology companies that hires thousands of workers, which may be lead to mass unemployment. In order to backstop the contagion from spreading, the US Federal Reserve stepped in to protect the deposits of the failing banks, allowing the bank to pledge their long term bonds for cash.
So here is where the dilemma for the US Federal Reserve.. If rates continue to go up quickly, it could pose more problems for more banks. That’s got the Fed in a bit of a pinch. It wants to tame inflation, which remains high, and it also wants to ensure financial stability. Both fronts are looking quite tricky.
To be sure, SVB had other particularities to it. It catered to a clientele base highly exposed to the technology industry, meaning if that industry faltered, so would it. It also held a high amount of uninsured deposits. Silvergate and Signature, which have also collapsed, had dipped into crypto, which has also been struggling.
That rate hikes might be a problem for banks now becomes a problem for the Fed, because it doesn’t want to break the banking sector. Before SVB’s meltdown, many investors expected the central bank to keep pace with rate increases when policymakers next meet on March 21 and 22. Now, that’s changed. Many investors, analysts, and experts think that they will slow down or even put a pause on it altogether.
Portfolio Performance and Strategy
That portfolio is more or less flat during Feb 2023 with Cash -0.34%, CPFOA -0.79%, SRS -0.37%. Remember that I mentioned in previous iteration of the news letter that "bad news is good news?" This is the bad news that could potentially change the trajectory of the rate rise. The Fed now has to walk on a tight balancing rope to prevent the US economy from plunging into a recession due to a banking financial crisis while managing a still high inflation. It is possible that the Fed will slow down their rate rise, or even pause the rate rise for the up coming meeting, in order to calm the roiling banking sector. All these news are actually positive for the stock market, especially for tech companies, which has out paced the wider index in the past few days. Meanwhile, bank stocks are now under pressure as fears of a contagion causes investors to sell banking stock.
With the latest development, there won't be any change in the portfolio allocation for now as we are well positioned to take advantage of a pause in the rate rise.
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