The impact of the last month on markets has been stark. In February the primary concern was that the economy was holding up better than expected and monetary policy may therefore need to be tighter. However, these higher bond yields were the final straw for Silicon Valley Bank. The cause of the bank’s collapse is now widely known, however, only a couple weeks earlier, few would have been able to identify the issue. Similar to the Gilt market selloff experienced in the UK during October 2022, the episode is an illustration of the unforeseen impacts of the rapid change in monetary conditions that have been experienced.
The issues with Silicon Valley Bank (SVB) originate in the very loose monetary conditions following the onset of the COVID pandemic. A strong funding environment for tech companies in 2021 led to exceptional deposit inflows into Silicon Valley Bank. The bank looked to deploy this excess into longer maturity bonds, earning a spread over the low interest paid on deposits. However, as interest rates and bond yields rose, the value of those bonds fell, to the extent that they no longer covered the value of their deposits. As depositors realised this, they began withdrawing cash at an increasing pace. Given the business model of SVB was to service corporate tech clients, typical accounts were in excess of the $250,000 deposit insurance amount, which exacerbated the issue. Ultimately, government guarantees allowed remaining depositors to access their funds.
Although several measures were implemented by the US government and Federal Reserve that aimed to limit contagion and calm market fears, a number of other regional banks came under pressure. Investor concern also spread to Europe, singling out the weakest bank in the region, Credit Suisse, which also made an untimely announcement around uncertainty in its accounts. Similar deposit outflow pressure was layered on an already weak balance sheet leading to a forced takeover by Swiss rival UBS. The market is now on the lookout for the next casualty.
While Credit Suisse may or may not be the last banking failure of this crisis, it is highly likely that behavior will be impacted. Liquidity will be priced at an increased premium in the short term in the banking sector and broader economy. Lending standards in banks will be tightened and companies will be less willing to take on debt. Economic activity will be weaker as a result. The offsetting factor is that interest rate expectations have also moderated significantly, and bond yields have fallen. The balance in outlook has therefore shifted to a lower growth, lower interest rate environment than was expected only a few weeks ago.
For investors, the month has been a positive illustration of traditional fixed income, equity diversification. Government bonds rallied hard on days when the equity market was at its weakest, reversing the trend that established in 2022. Resultingly, more cautiously invested portfolios may have seen positive returns in the month. Lower bond yields have also held up equities in a backdrop that would otherwise be a significant headwind.
