"Danger, Will Robinson!" Flight to safety

Investment Analysis Clubs Macro Economic Trends and Risks
1

As I posted yesterday in the Control Panel, the markets showed risk-averse flight to safety on Friday.

My “Risk Panel” shows how the SPX and junk bond fund fell even as the price of the 10 year Treasury rose. The panels showing the ratios had large gaps, showing unusual risk aversion. Investors are buying Treasuries hand over fist.

This action is continuing today. It’s international.

Banking Crisis Powers Historic Bond Rally

Turmoil in the banking sector sparks rapid downward move in Treasury yields

By Sam Goldfarb and Matt Grossman, The Wall Street Journal, March 13, 2023

Turmoil in the banking sector sparked a furious rally in government bonds Monday, with yields on some shorter-term Treasurys collapsing half a percentage point in hours.

Yields, which fall when bond prices rise, started falling during the Asia trading session soon after U.S. regulators, including the Federal Reserve, announced measures on Sunday night intended to mute the fallout from Silicon Valley Bank’s sudden collapse on Friday. They then took another nosedive when trading opened in Europe and continued to slide at the start of U.S. trading, while stock indexes wavered… [end quote]

I bought a 17 week T-Bill at last week’s auction with a market yield of 5.2%. Today, everyone with more than $250,000 in a bank account seems to be buying 3 month T-bills. The T-bill yield suddenly fell to 4.6% at the opening but has recovered to 4.8%. This is very unusual behavior. Other durations also dropped. The entire yield curve fell.

The Fear and Greed Index is in Extreme Fear.

The stock market has stabilized. VIX is up but not to a panic level. It’s too soon to see changes in the Financial Stress and Financial Conditions indexes. They are only up to March 3.

February 2023 CPI data are scheduled to be released on March 14, 2023, at 8:30 A.M. – that is, first thing tomorrow morning.

If inflation is higher than the Fed’s target of 2% (which it almost certainly will be) the Fed will be put in a bind. The Fed wants tightening of the economy. They don’t want the yield curve to fall which will stimulate the economy. If inflation is high they will want to raise the fed funds rate. Last week’s strong employment data caused the markets to expect the next raise to be 0.5% instead of 0.25%.

The SVB and other bank failures show that the Fed’s policy of ultra-low rates followed by fast increases blindsided (some) banks. The management of the banks can be criticized but the fact is that the government created trillions of dollars in ultra-low-interest Treasury debt during 2020 and 2021 and someone is holding that hot potato of loss.

If the Fed raises the fed funds rate it will be criticized for tightening the screws on banks (and other investors) that are already suffering. If the Fed doesn’t raise the fed funds rate it will be blamed for not attacking inflation.

The Fed is already being criticized for the moral hazard of bailing out SVB depositors over the $250,000 FDIC insurance limit which may cause expectations for future bank failures.

It seems as if the actions of the Fed, FDIC and Treasury over the weekend have reassured the stock and bond markets enough to prevent a panic. But it’s a little soon to tell for sure.
Wendy

6 Likes
2

On this - I don’t see a lot of moral hazard here. Not even much of a bail out.

I’ve looked through their financial statements, and the assets (at current values) of Silicon Valley Bank are roughly equal to their liability to depositors. So the FDIC isn’t bailing out depositors in any significant way. My back of the envelope numbers showed depositors would lose no more than 3% of their deposits, and that’s only if depositors and general creditors shared the paper losses equally. It’s not hard to push most of the losses on the creditors, especially since the bulk of the credit was incurred in the last year as the Bank attempted to avoid selling investments at a loss by borrowing against them instead. Presumably those lenders knew what they were doing.

The real risk to depositors would have been the tying up of their cash for some period of time while the bank’s assets were sold and cash raised to pay back depositors. And the reality is that much of the bank’s assets which currently have a paper loss are not going to lose money over the long term. They are bonds which will return par value in the future, but are trading at less than par due to their low interest rates.

I suspect this is why the Fed, FDIC, and Treasury were willing to backstop things and make depositors whole and make all of their deposits available as if the bank hadn’t been closed by regulators. There is little to no financial cost to the agencies, but the goodwill - confidence building - reassurance - whatever you want to call it - in the general public is highly valuable. It will make runs on other banks less likely and keep the agencies from having to step in again and again.

In short, there is no bail out of depositors. At least nothing significant. So I believe any criticism of the Fed/FDIC/Treasury for their actions is misplaced.

And since the Fed governors seem to be wearing their big boy and girl pants lately, I suspect that criticism will be mostly ignored - as it should be IMHO. Which means that if inflation is still up and employment remains very hot, they will raise rates as previously expected at their next meeting. The suffering of banks and investors is not the Fed’s problem. Their problems are inflation and employment, both of which are still very hot, so both require a further increase in interest rates.

–Peter

6 Likes
3

For the peeps who did not “get” Wendy’s title, this mite jog your memory.

dangere

4 Likes
4

This is a game of triage.

The second largest bank failure in our history is like treating a heart attack.
High inflation is like treating high cholesterol.

Ya, both are bad but one requires immediate attention. Bond market is acting like the Fed is about to blink and pause for awhile - or at least take the 50 basis point increase off the table. Future markets are now pricing in interest rate deceases by the end of the year (again).

Snip:
Federal-funds futures, which indicate bets on changes to the Fed’s benchmark rate, were whipsawing Monday morning. Chances of no change in interest rates after the Federal Open Market Committee’s Mar. 21-22 meeting were last around 30%, according to the CME FedWatch Tool, with pricing for the terminal rate—the peak of rates in the current hiking cycle—also falling.

1 Like
5

SVB Paid Out Bonuses Hours Before Seizure | Newsmax.com

At least they got the bonuses before they closed down. Also it was fortunate that some got their money out before the closure.

Peter Thiel’s Founders Fund got its cash out of Silicon Valley Bank before it was shut down, report says (businessinsider.nl)

including the SVB CEO and other investors:
Silicon Valley Bank CEO Sold $3.5 Million in Stock 2 Weeks Before Collapse (msn.com)

good read…doc

1 Like