Next steps
The Fed’s response to the collapse of SVB puts pressure on the Treasury and the FOMC decision next week.
Published March 14 2023
Deborah A. Cunningham, CFA
Executive Vice President
Chief Investment Officer Global Liquidity Markets
Senior Portfolio Manager
We think the ramifications of the recent tech bank failures—not a crisis—and the Federal Reserve’s intervention will be most significant for monetary policy. Just last week, markets were struggling to react to Fed Chair Powell’s rebuke of the markets’ stubborn optimism that the Fed might soon end its tightening campaign. His message that economic data continues to be too strong to quell inflation changed market projections for the FOMC meeting March 22, leading to an expectation of a 50 basis-point hike. Because the collapse of Silicon Valley Bank (SVB) and Signature Bank exposed the potential side effects of the Fed’s aggressive hikes, some now project it will hold the federal funds rate at 4.50-75%. We think the bank situation won’t break the Fed’s resolve, and it will deliver a quarter-point hike next week. The Fed’s determination to continue its fight against inflation should not be discounted or minimized.
A less-discussed ramification of the Fed’s new Bank Term Funding Program (BTFP) is that the Treasury Department backed it with a $25 billion pledge from the Exchange Stabilization Fund. That’s not good medicine for a government that has already hit its debt ceiling, as it reduces the Treasury’s resources. This puts new pressure on negotiations to raise or at least suspend the debt limit, as the issuance likely pushed the X-date up a few weeks.
Intriguingly, the collapse of SVB, et al, may actually help the Fed fight inflation. Understandably, people have long memories when it comes to banking turmoil and recessions. One potential outcome is that consumers keep more of their income in their pockets (for most, ironically, in banks) than spend it. That could finally cool what remains a stubborn factor in the economy of solid retail sales (though they did decline in February). Today’s CPI report showed inflation pulled back, with year-over-year headline and core growing at 6% and 5.5% compared to 6.4% and 5.6%, respectively, in last month’s report. Headline increased 0.4% and core 0.5% from February. The decline is welcome, but price growth still is more than twice as high as the Fed wants, hence our call for a quarter-point hike next week.
While the aftershocks may still claim more banks, though it seems unlikely, it is important to know that strict SEC regulations require money market funds to only invest in the highest quality issuers, which is why Federated Hermes’ money market, stable net asset value, microshort, ultrashort and fixed-income funds, as well as Treasury pools, do not have exposure to Silicon Valley Bank (SVB), Signature Bank or Silvergate. These regulations also require money market funds to be transparent to investors, so those same investors can monitor daily and weekly liquidity levels, specific issuer holdings, maturities of holdings and other elements. Treasury pools also are transparent, following the status quo requirements of their individual states. Trading has been volatile, with most liquidity products industry-wide in risk-off mode, meaning sticking with purchases of very short-term securities, primarily those maturing overnight. Few were buying floating-rate paper or 3-, 6-, 12-month Treasuries. Prior to next week’s FOMC meeting, it will not be surprising to see excess liquidity given the expectation of higher rates. However, based on industry asset flows yesterday and so far today, investors seem to be acting like nothing happened: some are purchasing, some redeeming but overall no unusual outflows.
It feels like the Fed is in an overtime game of policy basketball. Having already gone through a host of crucial scores to keep the game against inflation tied, the stakes are now even higher.
Not your traditional banks
While the tremors from the sudden collapse of Silicon Valley Bank (SVB) and Signature Bank are still being felt, we think the tumult will not spread into the greater banking system and cash management alternatives. That’s in part to the Federal Reserve’s pledge to make good on the deposits and its creation of a new Bank Term Funding Program (BTFP), but largely due to the atypical structure of these banks.
Each of these institutions relied on a highly concentrated part of the economy for their funding: SVB’s deposit base was highly exposed to the technology sector, in particular tech start-ups, while Signature also had heavy exposure to the risky crypto sector. Funding diversification is a core tenet of a traditional bank, with assets coming from throughout the broad economy. Their specialization left SVB and Signature vulnerable to withdrawals: a run from one sector is far more likely than a run on the entire banking system by a broader group of depositors.
SVB’s case was exacerbated by the mismatch between deposits and assets. Most of its deposits, upward of $150 billion, were held in around 37,000 accounts that were over the FDIC’s maximum $250,000 insurance level, according to the Wall Street Journal. Flush with funds from the run up in deposits during the pandemic, SVB invested in long-term Treasury securities. These holdings went underwater as the Fed rapidly cranked up interest rates, which translated to realized losses as SVB had to sell some holdings to offset deposit outflows.