The Economy Gets a Deflationary Jolt
As my grandmother used to say: It’s an ill wind that blows nobody any good.
The collapses in recent days of Silicon Valley Bank (SVB), Signature Bank, and Silvergate Capital have rocked the equity markets, especially the shares of regional banks. The technology sector has taken a big hit, too, because SVB catered to tech start-ups and entrepreneurs.
These bank failures have stoked fears that other undercapitalized banks, e.g. First Republic Bank (NYSE: FRC), will face a liquidity crisis as well.
But there’s a silver lining to this banking crisis. I’ll explain, below. First, some context.
Capital requirements and stress tests established for banks in reaction to the 2008 Financial Crisis have been eased in recent years, as pro-industry politicians and lobbyists pushed a more lenient stance toward the financial sector. In particular, Dodd-Frank was gutted by legislation enacted in 2018. Both political parties have sought banking deregulation.
WATCH THIS VIDEO: After SVB’s Collapse, Will The Dominoes Fall?
This loosening of capital requirements helped banks to boost their profit margins, which all worked out fine when the economy was growing and stable. But then the pandemic and Russia-Ukraine War came along, stoking inflation. Last year, the Federal Reserve started raising interest rates, which reduced the value of the existing bonds in which banks stashed their cash.
Rising rates and a slowing economy also squeezed bank customers, hence the run on deposit withdrawals that sank SVB, Signature, and Silverlake. To cover those deposits, the banks sold their bonds at a loss. When the music stopped, there weren’t enough chairs.
The sheer size in dollar terms of the bank failures that have roiled the U.S. financial system over the past week is similar to 2008, although this time around, the bulk of the losses are attributable to just two banks: SVB and Signature (see chart).
SVB was the second-largest bank failure in U.S. history; congressional hearings (and the usual political posturing) are likely. Indeed, some lawmakers are upset that the top executives of SVB paid themselves big bonuses last Friday, a mere hours before the Federal Deposit Insurance Corporation put the bank into receivership.
SVB CEO Greg Becker, who earned $9.9 million in compensation last year, dumped some $3.6 million in stock just days before the bank imploded, Bloomberg has reported.
It’s also worth noting that CNBC’s Jim Cramer last month heartily recommended shares of SVB’s holding company, SVB Financial Group, saying it was a “compelling” bargain-priced stock.
Now the good news…
Analysts on Wall Street often see bad news as good news. What’s so great about a banking crisis? Simply put, these recent regional bank woes represent a deflationary jolt to the economy.
After Fed Chair Jerome Powell’s hawkish testimony in front of Congress last week, the betting on Wall Street was that the Fed would hike rates by 0.50% at its next meeting on March 21-22. This level was a step-up from the previous expectation of 0.25%.
And now? The betting is that the Fed will either settle for an 0.25% hike, or maybe none at all.
In a note last Sunday, Goldman Sachs (NYSE: GS) stated that “in light of the stress in the banking system,” it no longer expects a rate hike next week.
Despite the turmoil generated by the banking crisis, the main U.S. stock market indices closed mixed on Monday with only modest losses, in choppy trading. We didn’t get the rout that some had feared.
Investors also have been impressed by the speed with which federal regulators have acted. All customers of the failed banks have been assured that they’ll be made whole, even if their accounts don’t fall under the FDIC’s $250,000 limit.
The latest inflation report also provided encouraging news. The U.S. Bureau of Labor Statistics reported Tuesday that the consumer price index (CPI) continued to cool off last month.
CPI measured 6% for the year ended in February, down from January’s 6.4% and in line with consensus expectations.
On a monthly basis, the CPI climbed 0.4%, representing a slowdown from the January monthly growth rate of 0.5%. Economists were expecting a gain of 0.4%.
When removing volatile energy and food prices, core CPI grew 0.5% on a monthly basis (versus the estimate of 0.4%) and 5.5% year over year (in line with estimates).
The new inflation data cheered investors. The main U.S. stock market indices closed sharply higher Tuesday, as follows:
- DJIA: +1.06%
- S&P 500: +1.68%
- NASDAQ: +2.14%
- Russell 2000: +1.87%
Bank stocks rebounded Tuesday, particularly previously hard-hit regional banks. The SPDR S&P Regional Banking ETF (KRE) clawed back some of its recent losses and closed 2.09% higher. The CBOE Volatility Index (VIX) plunged more than 10%.
The CPI report was interpreted as generally positive. The combination of easing inflation and banking woes makes less of a case for continued aggressive monetary tightening.
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John Persinos is the editorial director of Investing Daily.
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