The Fed Doesn’t Want to Break the Bank
We believe monetary policy acts with a lag, that it takes months, if not years, for changes in the Fed Funds Rate to impact the economy. That dynamic is one reason why the Fed often goes too far one way or the other, leaving rates too low for too long which leads to more inflation than the bank desires, or raising rates too fast and too far which leads to the recessions the bank seeks to avoid. We think this is a point worth making now for two reasons: we are about to mark the anniversary of the first Fed Funds Rate hike of this cycle and Fed policy decisions of the past three years had a meaningful impact on the US banking sector last week, particularly Silicon Valley Bank (SVB).
As it concerns the former, the Fed raised the Fed Funds Rate by 25 bps at its March 2022 meeting, and the market – despite the hawkish testimony of Chairman Jay Powell before Congress last week – expects the Fed to raise rates by 25 bps when it meets next week, taking the Fed Funds Rate to a range of 4.75% to 5.0% (a year ago, the Fed Funds Rate was in a range of 0% to 0.25%). As it concerns the latter, Wall Street was unnerved last week as it came to appreciate that many banks are sitting on significant – if unrealized – losses in their fixed income portfolios, as the bonds they purchased when rates and yields were near zero are worth much less today now that rates and yields are much higher. These “paper losses” are typically not an issue for banks as they tend to hold bonds to maturity. But in the case of SVB, the bank last week recognized a loss of $1.8 billion on the sale of $21 billion worth of securities, a development that sparked a 60% fall in its share price and the sharpest drop in the KBW Nasdaq Bank Index since 2020 (see chart).
As we took pen to paper on this week’s note, SVB had been shut down by regulators, making it the second-biggest bank failure in US history. We don’t think the failure of SVB portends systemic risk for the banking sector – we think the industry is too well-capitalized and the economy is too robust. We do think the failure of SVB is a reason for the Fed to consider again the impact its rate hikes of the past year have had (and will have) on the economy and to consider again the importance of raising the Fed Funds Rate by only 25 bps at its upcoming meeting.
The views expressed are those of Brinker Capital and are not intended as investment advice or recommendation. For informational purposes only. Brinker Capital Investments, LLC, a registered investment advisor. 730-OPS-3/13/2023