Regulators were acting swiftly to get ahead of concerns about the health of the banking system. These concerns sent equities and bond yields down sharply last week as markets digested the Friday closure of SVB Financial Group, the 16th largest bank in the US and the biggest to fail since the 2008 financial crisis.
The crisis action has helped backstop market sentiment after a tough week, with S&P 500 futures gaining 0.2% early Monday. Last week, the S&P 500 closed 4.6% lower, its worst weekly performance since September. The S&P bank index fell 6.6% on Thursday, and then a further 0.5% on Friday.
Two-year Treasuries have fallen more than 80 basis points from their Wednesday high to 4.25%, and the inversion of the 2-year/10-year yield curve has narrowed to 70bps from 109bps on Wednesday. Fed funds futures markets are now pricing in a lower terminal rate of 4.84% in June, down from a peak of 5.69% last week. The DXY US dollar index has dropped 0.4% to 104.2pts.
The failure of SVB and Signature Bank has raised concerns over potential losses on the bond holdings of other US banks, many of which invested heavily in long-duration Treasuries following an influx of deposits during the pandemic. The value of these securities has fallen as the Fed has raised rates. The FDIC recently warned that US lenders face USD 620bn in unrealized losses in their securities portfolios. Meanwhile, investors have shown concern that clients could withdraw deposits in favor of higher yielding short-duration bonds.
The Fed has announced that it will hold a closed-door meeting of its board of governors under expedited procedures on Monday 13 March, and US President Joe Biden has hinted at new regulation with plans to address the banking crisis on Monday morning.
SVB’s collapse overshadowed Friday’s release of the US labor report for February, which showed nonfarm payrolls increasing by 311,000, while the unemployment rate rose to 3.6% from 3.4% and wage growth moderated.
What does it mean for investors?
We think the policy actions announced so far are strong signals that US officials will do what they can to keep this from becoming a series of bank runs and prevent a systemic crisis in the US banking sector. We are not currently seeing classic signs of contagion, such as stress in the interbank market. Meanwhile, the USD 620bn of estimated unrealized losses compares to total equity of USD 2.2 trillion for the industry and total realized losses last year of USD 31bn, according to the Financial Times.
The financials sector accounts for 15% of the MSCI ACWI index, and we are neutral on it globally. Within that space, we are neutral on European financials and have held a least preferred view on US financials for some time due to concerns over rising fund costs, risks around credit costs and rising unemployment, and weak capital market activity. But at this point, we believe the headwinds to the sector can be managed.
Since the Global Financial Crisis, banks have been required to keep their liquidity coverage ratio above 100%, holding enough high-quality assets to meet deposit outflows. In practice, this has meant they tend to hold significant quantities of US Treasuries.
The banks are allowed to hold these bonds in so-called "Available For Sale" and "Held to Maturity" accounts at cost, and are not required to recognize mark-to-market losses immediately if the bonds lose value. Banks might have to crystalize losses if they have significant deposit outflows that need to be met. But such outflows could also be stemmed by raising deposit rates, though this would reduce earnings. In addition, the value of the unrealized losses would shrink if rates fall.
In our view, the SVB situation is somewhat unique. With a heavy focus on clients in Silicon Valley, the bank has a large concentration to venture capital sponsored start-ups which expanded significantly during the pandemic and were flush with cash which was held on deposit at SVB. These start-ups are now burning through their cash at a rapid rate, driving a decline in SVB deposit balances and apparently forcing the bank to sell investment securities at a loss and attempt to raise capital.
The SVB situation is a reminder that Fed hikes are having an effect, even if the economy has held up so far. Concerns over bank earnings and balance sheets also add to the negative sentiment for the country's equity markets. While investors will be relieved that SVB should be a contained risk, we think the fundamental outlook for the next 6–12 months hasn’t really changed, with both a soft and hard landing still very plausible scenarios.
How do we invest?
We remain least preferred on financials in our US strategy and recommend investors who have above-benchmark weights in global financials (15% of the MSCI ACWI) to revisit their exposure. Instead, we favor switching the excess exposure into more defensive areas, given the increasing risks to the US economy. We prefer the global consumer staples sector, where the relative earnings momentum is positive and strengthening.
In addition, we currently favor high-quality segments within fixed income. We think that all-in yields remain appealing, particularly relative to opportunities in other asset classes. Investor demand for fixed income exposure has also increased. We maintain a preference for high grade and investment grade corporate bonds. In corporate high yield (HY), slower economic growth and earnings in developed economies suggest higher default risk in the future, and we have a least preferred stance on HY.
Main contributors - Mark Haefele, David Lefkowitz, Jason Draho, Vincent Heaney, Jon Gordon
Content is a product of the Chief Investment Office (CIO).
Original report - US takes action to stabilize banks after SVB collapse, 13 March 2023.