Investors have revised their predictions for more interest rate increases as a result of Silicon Valley Bank’s failure, and bank equities have been dumped all around the world.
In response to fund managers’ increased bets that the US Federal Reserve would now maintain interest rates at its upcoming scheduled monetary policy meeting this month in order to stabilise the global financial system, government bond prices soared on Monday, with two-year US Treasury yields recording their biggest one-day drop since 1987. Markets were preparing for an additional increase of 0.5 percentage points as recently as last week.
After US regulators announced on Sunday that SVB depositors would be fully repaid and unveiled emergency funding measures in an effort to contain the fallout, Wall Street’s S&P 500 and the tech-heavy Nasdaq Composite lost earlier gains in futures markets, falling 1% and 0.8%, respectively, shortly after the New York open. The UK’s SVB UK arm was sold to HSBC for £1 thanks to a deal facilitated by the Bank of England.
Stocks in banks fell sharply in the meanwhile. Notwithstanding a statement on Sunday indicating it has more than $70 billion in unused liquidity, shares of First Republic, another San Francisco-based bank, fell by 60% before trading in its shares was suspended shortly after the open. Just after the opening, the KBW bank index, which covers bigger lenders, dropped 13%; Citigroup was down 6%.
The 22 stocks that make up Europe’s Stoxx Banking Index all experienced losses, bringing the index’s decrease since mid-last week to just over 11%. Many lenders, like Germany’s Commerzbank and Spain’s Bank Sabadell, had double-digit reductions alone on Monday. The Bawag Group in Austria decreased by 8.9%.
Only months after the brief crisis in UK government bonds, SVB’s bankruptcy and Signature Bank’s liquidation highlight the hazards hidden in the financial system as central banks swiftly raise borrowing costs in response to the Covid-19 pandemic. Analysts and investors warned that in their efforts to curb inflation, policymakers at the Fed and elsewhere would need to exercise caution.
Even while the economy has so far held up, the SVB issue serves as a reminder that Fed rate hikes are having an impact, according to Mark Haefele, chief investment officer at UBS Global Wealth Management. Worries over bank profitability and balance sheets also contribute to the unfavourable outlook for equities markets.
Despite Fed chair Jay Powell’s reminder a week ago of his determination to pull down inflation and despite data on Friday showing that the US economy added 311,000 jobs, higher than the 225,000 forecast by economists, futures markets indicate investors believe the US central bank will temper the path of interest rate rises going forward.
Refinitiv data now indicates that traders perceive a 60% probability that the US central bank would leave rates steady later this month, in a range of 4.5-4.75 percent, after weeks of discussion about whether it would hike interest rates by 0.5% or 0.5 percentage points.
The bond markets saw a significant upheaval. On Monday, bond markets erupted in response to dwindling prospects of additional hikes in borrowing costs, driving down the yield on Germany’s interest rate-sensitive two-year bond by 0.48 percentage points to 2.62 percent. Since the collapse of SVB, investors have dramatically revised their rate expectations, as evidenced by the rate’s decline from the 14-year high of 3.3% it reached last week.
In the US, the two-year Treasury yield, which swings with interest rate predictions, decreased by 0.41 percentage points to 4.18 per cent. It had earlier dropped to its lowest point since September, below 4%. The 10-year government bond yield that is used as a benchmark fell 0.22 percentage points to 3.47 percent.
Deutsche Bank strategist George Saravelos claimed that the SVB rescue package from the Fed, which includes an offer to buy government debt and mortgage-backed bonds above market rates, represented a new type of quantitative easing, the bond-buying programme that US policymakers launched to stabilise the financial system after the pandemic struck.
Both the rate and the timing of the Fed’s cycle of rate increases should slow down, according to Saravelos. “During the past three days, we have discovered two things. Secondly, this tightening cycle of monetary policy is functioning with a lag, just like every past cycle. Second, the stress in the US banking sector will now cause this tightening cycle to be accelerated.
The Fed’s “bailout of Silicon Valley venture capitalists backing Instagram filters that make cats appear like dogs,” according to Rabobank analyst Michael Every, could have “enormous” ramifications.
“The Fed is de facto enabling a significant relaxation of financial conditions as well as skyrocketing moral hazard,” he said in a message to investors.
Moreover, currencies that do well under pressure surged. In relation to the dollar, the Japanese yen and the Swiss franc both increased by more than 1%.
Market participants are “more aware again that the Fed will eventually break something if it keeps rising rates,” according to Lee Hardman, currency analyst at MUFG, as a result of the swift fall of SVB.
By spotlighting the risks related to rising rates, the bank’s failure had also “taken the wind out of the US dollar’s sails,” according to Hardman. On Monday, a gauge of the dollar’s strength against a group of six international counterparts decreased by 0.6%.