The art of banking is always to balance the risk of a run with the reward of a profit…. A good banker safely and profitably treads the middle ground.” - Jim Grant: Founder of Grant’s Interest Rate Observer
Last week's market recap:
- The S&P 500 closed the week down -4.51%. Year-to-date the index is up .92%
- NASDAQ closed the week down -4.68%. YTD the index is up 6.63%
- U.S. Aggregate Bond index was up 1.17% for the week. YTD the index is up 1.45%
- 10-Year Treasury Rate decreased, ending the week at 3.70% down from 3.97% the prior week.
- Fed Funds Target rate is 4.75%
- The 1-Year Treasury is yielding 4.41%
- A 6 Month Treasury is yielding 4.74%
The week ahead:
- CPI (Inflation Data)
- PPI (Inflation Data)
- Retail Sales
Silicon Valley Bank, Interest Rates, and the Market:
Last week, the Fed signaled that it is likely to take rates higher and keep them there longer. On Wednesday, 3/15, the market was pricing in a 80% probability of a 50 basis point rate hike at the Fed’s next meeting on 3/22. After news broke about Silicon Valley Bank’s collapse, the market priced in a 40% probability of no hike at all!
- Over the last year, The Fed has raised interest rates by 450 bps, from .25% to 4.75%. Rate increases cause bond values to fall. Last year, if you bought a 10 year Treasury Bond at 1.6% (Silicon Valley Bank bought a lot of them), and the current market rate on the 10-year US Treasury rises to 4%, who would want to buy your 1.6% bond? No one. You have to lower the price until the combination of price and lower yield make it attractive to a buyer.
- Banks hold US Treasuries and Agency Mortgage Backed Securities for liquidity purposes. If a customer withdraws money, the bank sells the bonds for cash to return to the customer.
- Silicon Valley Bank’s deposits tripled between 2019 and 2021. They couldn’t lend the money out fast enough, so they decided to pick up some extra yield by purchasing longer dated assets. ie: 10 year Treasuries yielding 1.6%.
- Silicon Valley Bank failed because their management team took too much duration risk with depositors money. Instead of buying short term T-Bills, they bought longer duration bonds to earn a little extra yield. This caused an asset-liability mismatch. When everyone wanted their money back at the same time, they had to sell their already depressed assets and realize the loss.
The Silicon Valley Bank story is clearly poor risk management, but it also about interest rates. Jerome Powell and the Fed didn’t cause the bank to fail. Silicon Valley Bank didn’t “safely and profitably tread the middle ground.” HOWEVER, “things break” when you raise rates almost 5% in a year. If the Fed wants to break more banks, they can continue to raise rates, and test risk management departments across the banking sector. The Fed probably doesn’t want to cause more bank closures. The Terminal Rate is probably in sight, maybe already here.
Below is a chart following the Terminal Rate:
Source: Blackrock * https://www.blackrock.com/us/financial-professionals/insights/student-of-the-market
What would happen if Schwab had a bank failure?
This sums it up well:
You’re securities would most likely move to another brokerage firm.
Please reach out to us if you have any questions or if you’d like to discuss any of the details above.
CRA Investment Committee
Matt Reynolds CPA, CFP®
Tom Reynolds, CPA
Robert T. Martin, CFA, CFP®
Gordon Shearer Jr., CFP®
Jeff Hilliard, CFP®, CRPC®
Joe McCaffrey, CFP®
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