SVB collapse forces bank stocks to be impacted and interest rates to be rethought

Investors are dumping bank stocks and revising their forecasts for higher interest rates as a result of the failure at Silicon Valley Bank.

On Monday, the prices of government bonds soared. The two-year US Treasury yield recorded its largest one-day drop in 1987. Fund managers bet that the Federal Reserve would stabilize the global financial system and leave interest rates unchanged at the next scheduled monetary policy meeting. Markets were expecting another half-percentage points increase as recently as last week.

The two-year Treasury yield, which is linked to interest rate expectations, dropped by 0.59 percentage point to 4.1%, its lowest level since September. The benchmark 10-year government bond yield fell 0.14 percentage point to 3.54 percent.

SVB was seized by regulators last Wednesday after customers tried to withdraw their money in one of the most important tests of the US financial system’s history since 2008. Joe Biden, the US president, sought to assure Americans that their money was safe and promised to do whatever it took to safeguard bank deposits. The Bank of England arranged a deal to transfer the UK arm of SVB over to HSBC in exchange for PS1.

Despite this, bank stocks fell as investors worried about what other institutions might be under stress.First Republic shares dropped by as high as 79% and were stopped 15 times during the first two-and a half hours of trading. This despite First Republic’s San Francisco-based bank telling investors that it had $70bn worth of liquidity. The bank closed the day with a drop of 61.8 percent.

The KBW bank index, which is comprised of larger US lenders, dropped 11.7 percent.

Europe’s Stoxx bank index dropped 6.7%, bringing its decline to more than 11% since the middle last week. All 22 stocks included in the index are now in negative territory. On Monday, several lenders experienced double-digit drops including the Commerzbank in Germany and Banco Sabadell in Spain. Bawag Group in Austria fell 8%.

Signature Bank and SVB collapse just months after the short-lived crisis in UK government bond, underlining the risks in the financial system. Central banks are increasing borrowing costs rapidly so the failure of Signature Bank and SVB is a major setback. Analysts and investors agreed that policymakers will need to be cautious in attempting to reduce inflation.

In a note to clients, Mark Haefele (chief investment officer at UBS Global Wealth Management) stated that the SVB situation was a reminder of how Fed hikes have an effect even though the economy has not suffered. Negative sentiment also increases due to concerns over bank earnings and balance sheet. . . Equity markets

Investors believe that recent developments suggest the Fed will relax its campaign to raise interest rate after weeks of debate about whether it would opt for a 0.25 or 0.5 percentage point increase. This is after weeks of deliberation over whether it would choose to increase its rates by weeks’ end.

According to Refinitiv data, traders now see an almost equal split between the chances of a quarter point rise and the Fed leaving rates the same.

Goldman Sachs stated Monday that it does not expect any rate increase at the Fed’s March 22 meeting “in light recent stress in banks”. On Monday, Nomura, a Japanese bank, stated that it expects the Fed to reduce interest rates by 0.25 percent at its March meeting.

The bond market shakeup was significant. The German interest rate-sensitive 2-year bond yield fell to 2.4 percent on Monday as the market rallied in response to falling expectations of higher borrowing costs. This is a sharp decline from the 3.3 percent it reached last week (a 14-year high), which shows how investors have revalued their rates expectations since SVB’s collapse.

Greg Peters, cochief investment officer at PGIM fixed income, stated that he believes the rally in government bonds is misplaced. It’s a far too large move. He said that the markets were overreacting and had completely forgotten about inflation. This is a huge head fake.

However, some analysts and investors, including George Saravelos from Deutsche Bank, stated that the Fed’s SVB rescue package, which offers to absorb government debt as well as mortgage-backed bonds at market prices, was a new type of quantitative easing. This is the wave of bond-buying that policymakers used to stabilize the financial system over the past decade.

Saravelos stated that both the speed and the end point of the Fed’s hiking cycle should be lowered, and added that tightening will now be “amplified by stress in the US bank system”.

Michael Every, an analyst with Rabobank, stated that the Fed’s bailout of Silicon Valley venture capitalists funding Instagram filters to make cats look like dogs was potentially “enormous”.

In a note to clients, he stated that “The Fed is defacto allowing a massive ease of financial conditions and soaring moral hazards.”

The rally was also driven by currencies that are resilient to stress. Both the Japanese yen (Japan) and the Swiss Franc (Switzerland) rose more than 1% against the dollar.

According to Lee Hardman, a currency analyst at MUFG, the rapid collapse of SVB has made market participants “more conscious again that Fed will eventually break something if they keep raising rates”.

Hardman said that the bank’s collapse had “taken out the wind from the US dollar’s sails”, by highlighting the risks associated with rising rates. On Monday, the dollar’s strength was measured against six international peers by falling 0.6%.