After a sharp decline across capital markets on the back of the failure of Silicon Valley Bank (SVB) and contagion concerns, regulators stepped in to backstop the firm’s uninsured depositors and took control of Signature Bank, one of the primary banks for cryptocurrency companies. The Federal Reserve (Fed) also announced a new lending facility to help safeguard deposits across the industry, offering loans up to one year to financial institutions that pledge government debt, such as U.S. Treasuries, agency debt, and mortgage-based securities as collateral at par (rather than marked to market).
The Fed’s action is an important step as it greatly reduces systemic risk and aims to restore depositor confidence. Our bigger picture view is the events of the past week speak to stresses in the financial system that are a byproduct of significantly higher interest rates.
Indeed, a key reason behind our stay defensive theme coming into the year was our concern that the sharpest Fed policy tightening cycle in 40 years would result in market and economic challenges. Historically, sharp interest rate increases have led to market disruptions, especially in areas with excesses and leverage. Developments over the past week appears to be a sign that these sharp interest rate increases are starting to bite.
Historically, sharp interest rate increases have led to market disruptions, especially in areas with excesses and leverage.
It’s important to recognize that even before SVB’s collapse and Signature Bank’s takeover, lending standards by U.S. banks were already tightening at a rapid pace, according to the Fed Senior Loan Officer Survey. If anything, what has transpired over the past week is likely to lead to even tighter standards. This is important as credit is the lifeblood of the economy. Slower lending trends have tended to weigh on the economy and corporate profits, and we have yet to see the full impact of the rate hikes of the past year filter into the economy.
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