Market Update: Banking Industry Intervention Puts Fed’s Policy Path in Flux
March 15, 2023
By Peter R. Phillips, CFA®, CAIA®
Senior Vice President and Chief Investment Officer
Washington Trust Wealth Management
The recent failures of Silicon Valley Bank (SIVB) and Signature Bank (SBNY) are troubling but appear to be mostly attributable to their specific customer, deposit base and investment security portfolio exposures. Both banks had deposit bases comprised heavily of large, non-FDIC insured deposits; and both banks had high-quality but longer duration investment security portfolios (used as a source of funding for customer deposit withdrawals) that declined in value over the past year due to the sharp rise in interest rates. This combination left both banks susceptible to a liquidity crunch if faced with an inordinate amount of customer deposit withdrawals, which unfortunately occurred late last week. Further, both banks’ high exposures, and/or perception of exposures, to industries such as private equity, venture capital and cryptocurrency (in the case of SBNY) had an impact on recent high deposit withdrawal demand.
While some banks face similar challenges, contagion to the broader banking industry seems limited - especially with the establishment of the Fed’s Bank Term Funding Program (BTFP)1. The BTFP was established on March 12, 2023, following the regulatory takeovers of SIVB and SBNY and offers loans of up to one year on pledged eligible collateral to federally insured banks, savings associations, credit unions, and other depository institutions in order to assure banks have the ability to meet the needs of all their depositors. In addition, the banking industry is much better capitalized than prior to the global financial crisis (GFC) and loan credit quality remains quite strong.
Recent developments in the banking industry certainly put in flux the near-term path of Fed policy. Prior to March 10 and the collapse of SIVB, the expectation was for the Fed to continue its path of rate increases and for the Fed funds rate to rise to a 5.50%-5.75% target range2, up from the current target range of 4.50%-4.75%. Now the expectation is for the Fed to pause with rate increases and then begin reducing the rate as early as their June meeting. We will get an update into the Fed’s thinking and intentions next week (March 22) following the Federal Open Market Committee’s (FOMC) meeting and Chairman Powell’s post meeting press conference.
In any event, we continue to have a cautious outlook on the economy and financial markets. We expect U.S. GDP growth to slow in 2023, impacted by the fastest and largest Fed funds rate increase cycle since the 1980’s3. Fixed income and equity markets are likely to remain volatile reflecting the uncertain path of Fed policy. And equity markets remain vulnerable to a reduction in corporate earnings estimates, which still seem a bit too high and not consistent with underlying economic growth expectations. We also expect U.S. government debt ceiling concerns and related news stories to start to impact investor sentiment as the spring and summer months approach.
On a positive note, a Fed ‘pivot’ to a neutral or accommodative policy stance even if prompted by recent bank industry woes would likely be well received by investors. Coupled with the still strong U.S. labor market, it would increase optimism for a soft-landing or no-landing economic scenario, and a more constructive outlook for the financial markets.
Finally, regarding our investment exposure to SVB and SBNY, our internally managed equity strategies did not have exposure to either company. Certain of our third-party managed mutual funds, ETFs (indexed strategies), and separately management accounts (SMAs) may have exposure; and there may be exposure through FDIC insured Certificates of Deposits (CDs). We are reviewing these holdings and expect minimal to no client exposure.
As always, please reach out to your investment team should you have any concerns regarding the financial markets, economy, or your portfolio.
2 Based on CBOE FedWatch data as of March 7, 2023.
3 Factset, Morgan Stanley
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