CommSec
14 Mar 2023
Across the globe, sharemarkets have slumped over the past few days in response to the failure of two large US banks, Silicon Valley Bank and Signature Bank. Is this the start of a new banking or financial crisis? Or is it just fall-out from the aggressive rates hikes that we have been witnessing for months across the globe?
But before we delve into the reasons for the demise of the two US banks, let’s start ‘down under’.
Australia
Up front, it’s important to note that the Australian banking system is rock solid. Even if there is further financial contagion in the US, Australian banks are more locally focussed and have passed all the recent stress tests applied by regulators.
But the US banking woes cause investors to fret about the global economic outlook, and therefore the implications for the Australian economy. In the four sessions to Tuesday March 14, the S&P/ASX 200 lost over 5 per cent, dragging the key gauge further from record highs.
However, if the jitters about US banks are prolonged, and the domestic economic outlook is downgraded, then the Reserve Bank will need to determine whether further rate hikes are required. Already, traders have begun paring back rate hike expectations with a pause at the April meeting now priced in.
Gold prices have the potential to benefit from safe-haven gold demand. Mining and energy sectors are sensitive to concerns about the health of the global economy as well as fluctuations in the US dollar. Despite differences with US peers, sentiment on banks will be negatively affected by developments abroad.
A number of Australian companies were identified as banking with Silicon Valley Bank (SVB), and therefore at risk. But the fact that US financial authorities have ensured that all depositors will have access to their funds has eased any concerns.
Winners & losers
As always, events like a bank failure can have divergent effects. On the first day of trade after the bank collapses (Monday March 13), investors embraced safe-haven government bonds. In fact yields on 2-year treasuries fell 58 basis points over that single session and slumped over 100 basis points at one point over the three-day period, the most since October 1987. The drop in yields (and questions raised on the timing of future rate hikes) caused investors to reduce exposure to banks and lift exposure to technology.
Gold also benefitted from safe-haven flows, (rising 2.6 per cent). But oil prices fell around 2.5 per cent on worries about the future path of the economy. The US dollar lost value against major currencies on the risk that future rate hikes could be delayed, scaled back or abandoned.
Domestic safe-haven sectors remain the same – they include Consumer Staples like supermarkets, as well as telcos, property trusts and utilities.
Background to the latest sharemarket slide: It’s a confidence thing
A central feature of any banking system is confidence. If you don’t have confidence that you will be able to access your funds when you need them, then you will turn your attention to another financial institution.
And that key ingredient of confidence was no better displayed than with the recent failure of Silicon Valley Bank (SVB) – the second largest banking collapse in US history.
And notably the collapse of SVB also shows how quickly a crisis of confidence can affect a particular institution and also how quickly the loss of confidence can spread through the broader banking system.
Collapse of Silicon Valley Bank
The background to the collapse is important. Over the cheap money period of 2020 and 2021, SVB was successful in securing the banking services for the technology sector, especially venture-capital firms, tech startups and biotechnology companies located in the US tech hub of Silicon Valley, California. SVB elected to invest the deposit funds in longer-term securities, like bonds.
But the high interest rate regime of 2022 prompted the US economy to slow, impacting growth-orientated tech firms. As a result, SVB’s deposits dried up and some customers elected to withdraw funds to meet expenses.
With investments largely locked away and deposits falling, on Wednesday March 8, 2023, SVB sought to raise capital. Now we can’t be precise on what happened next but some customers no doubt worried about the ability of SVB to repay deposits. And that led to other customers expressing similar concerns. So much so that a run on deposits was estimated to have drained US$42 billion from SVB deposits on Thursday March 9, 2023.
The response
The following day the US Federal Deposit Insurance Corporation closed SVB and acquired all insured (and subsequently, non-insured) deposits.
The liquidity concerns spread to other institutions. Signature Bank was forced to close over the weekend. In response, the US Federal Reserve Board announced that it will provide additional funds to allow customers to access their deposits. The Fed also announced the creation of a new Bank Term Funding Program (BTFB), acting as a backstop to limit a run on regional US bank deposits.
Rather than being forced to sell high-quality securities to secure funding, the BTFB will provide the necessary liquidity to the bank, credit union or other approved institution.
Where to now: Interest rate impact?
Legendary investor Warren Buffett is quoted as saying that “It takes 20 years to build a reputation and five minutes to ruin it.” The same goes with confidence. So while the US financial authorities moved quickly to try and contain the ‘crisis of confidence’, it will take time for things to get back to something approaching ‘normal’.
The US Federal Reserve now needs to decide whether to proceed with another rate hike next week or to pause for a meeting or two to assess the full impact of the banking jitters on the broader economy.
If the recent bank failures have significantly affected business intentions to spend, invest and employ, the Fed may conclude that another lift in interest rates may weaken the economy too much. And while the all-important US inflation data released tonight will heavily influence policymakers alongside last week’s jobs report, the Fed may decide to prioritise “financial stability” over inflation fighting in the near-term.
Clearly it is a fine judgement and one that can’t be empirically proven. The policymakers will basically need to draw on their background and experience and make a call on rates.
It is different this time
The circumstances may differ, but what is being experienced at present is a stock, standard ‘crisis of confidence’. And once lost or degraded, confidence can take time to heal.
And while key public officials and regulators can say the right things, the vision of people queuing up to access deposits is quite powerful.
So investors will need to be patient, and monitor the developments over coming weeks. The circumstances and background may be a little different from the past, but the healing process has to run its course. This was demonstrated in the Global Financial Crisis, and all the ‘crises’ before it.
The volatility on global sharemarkets may continue for a little while longer. But the ‘big picture’ story on the Australian economy remains positive. And it pays to have that longer-term focus in times like this.
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