- Bank shares tumbled after the failures of two regional banks despite efforts from regulators to curb fears.
- Unique situations and factors at the two banks very likely led to their downfall, other banks should be largely unaffected.
- Implications for the larger market seem quite tame, though bond yields have seen dramatic moves.
- Fed rate expectations have changed considerably, with investors expecting officials to pause hikes at their next meeting.
After Friday's shock of the second largest bank failure in US history, markets responded surprisingly well and pared losses before slumping again today. Federal authorities responded aggressively, shuttering Silicon Valley Bank on Friday and Signature Bank on Sunday and announcing measures intended to head off additional pressure on the next weakest banks in line. Regional bank shares have tumbled 30.8 percent since Thursday, while the larger banking industry fell 15.3 percent. The S&P 500 declined 2.5 percent over the same period. The storm that clobbered several regional banks' share prices in particular, and financial names more generally, was quite severe—though the overall market implications appear quite tame. While much of the situation remains unresolved and further ripples may appear down the road, the specific concerns surrounding these failures don't seem to be a systemic issue.
The factors unique to the failure of Silicon Valley Bank are, at this point, well under discussion, and it appears only a few other institutions may have similar problems. Strangely, one of the main issues was its client demographics: many were venture capital companies or tech startups focused on cryptocurrency. When those clients anxiously came together to withdraw their deposits, a run on the bank ensued. Another key factor was how Silicon Valley Bank invested its deposits and assets, forgoing the typical mix of loans and diversified assets for a concentration in longer-dated securities. It became a crossfire largely of its own making.
Moving on to the bigger picture, the impact of this bank failure may have been the "sacrifice" needed to convince the Federal Reserve that a hawkish interest rate policy is actually working and that we may be closer to the end of the cycle. Bond markets have seen dramatic moves, with the benchmark 10-year Treasury yield falling from over 4.0 percent to 3.5 percent in just a few days. Functionally, these bank failures may have a cooling effect on inflation as the rest of the industry tightens lending standards, raises rates on nervous deposits, and generally reduces risk.
Given the mixed reports for employment last week and inflation this week, the Fed may see these as more than a modest step forward. Combined with the ongoing financial system issues, it seems a strong dovish wind is blowing through the Fed boardroom. While policymakers may be eyeing a 25 basis point hike, investors are now betting officials will instead hold rates steady at their meeting next week. Additionally, fed funds futures are showing that investors expect the Fed to actually cut rates in the next few months. There is still significant work in the fight against inflation, but the drama over the last several days should serve as a signpost that we may be getting to the end of that story.