Potential Impact SVB Collapse on Interest Rates

Most Federal Reserve rate hiking cycles tend to end when the economy tips into a recession or when something breaks and the Fed changes course to prevent further issues.  The economy does not seem to be currently in a recession, but something broke and in a big way.

On Friday, March 10^th Silicon Valley Bank (SVB) collapsed. According to Forbes, SVB, the tech industry’s go-to lender, was the second-largest bank failure in US history. After investor concerns about Silicon Valley Bank’s soundness prompted a bank run, the Federal Deposit Insurance Corporation (FDIC) took control of customers’ deposits, and the bank is for sale.  It is common for larger banks to buy the assets of smaller banks that fail.  Just two days later, Signature Bank was shut down by regulators, becoming the third-largest bank failure in US history.  According to Bloomberg, higher interest rates appear to be to blame for SVB’s collapse, while Signature Bank’s misfortunes seem tied to its bets on crypto currencies.

Expectedly, stocks did not react well to the biggest bank failure since the 2008 crisis. Last week, the Dow experienced its worst week since last June, and trading in several bank stocks were halted throughout the day on Friday as Silicon Valley Bank’s collapse provoked a wider sell-off. However, major banks JPMorgan, Wells Fargo, and Citigroup ended Friday higher.

Although SVB’s demise sent shockwaves through the banking sector, it could have been worse as banks’ finances are healthier now than they were in 2008, leaving traders optimistic that a full system disaster is not on the horizon.

Interest rate hikes take a while to work through the economy and now a year of hiking rates is starting to be felt by businesses and banks that can’t operate at these higher interest rates.  Goldman Sachs Group has scrapped its call for a Fed rate hike at next week’s meeting and many traders now see the peak Fed Funds rate at around 4.7% this summer, versus 5.7% just last week.  Stocks have seemed to have found their footing today, March 13^th, at least for a while and bond prices are surging due to a rapid collapse of interest rates.  The interest rate on a 10-year treasury fell from 4% to below 3.5% in just a few days, which is a seismic decline.  The bond market is betting that the Federal Reserve will need to stop hiking sooner than anticipated and maybe even start cutting rates later this year, which would be a boon to the bond market, and if the damage is contained, could aid a rebound in stock prices as well.

Time will tell if this does indeed signal the end of the Fed’s rate hikes for this cycle.  In any case, the damage to the economy brought on by the dramatic rise in rates probably won’t be known for a few quarters.  In this type of environment higher quality, well capitalized investments should be favored over more speculative ones.