Those failures ignited an exodus of deposits from the banking system, particularly from the smaller banks, with a flood of funds flowing into money market funds and, to a lesser extent, the big Wall Street banks.
Not surprisingly, it’s also seen a massive contraction in bank lending.
Silicon Valley Bank collapsed and was placed under the receivership of the Federal Deposit Insurance Corp on Friday, March 10, only a day after experiencing a one-day $US42 billion withdrawal of deposits. Its failure and that of Signature Bank two days later, sparked turmoil in the regional banking sector.
In the final fortnight last month – so, in the immediate wake of those failures – US bank lending fell heavily, with commercial bank lending plunging by just under $US105 billion. That’s the most on record and was weighted heavily towards smaller banks. Bank deposits also continued to fall.
The loss of deposits, but more particularly the anxiety-laden environment created by the bank collapses, would inevitably make the smaller lenders more risk-averse. In effect, by significantly cutting back their lending, they have tightened credit conditions at the coal face of the US economy.
The smaller banks originate more than half of all US banks’ commercial lending, including about 60 per cent of all housing loans, about half of all personal loans and 80 per cent of all commercial property loans.
The US bond market appears to be pricing in a decision by the Fed to continue to prioritise the fight against inflation.
It is the latter lending, or withdrawal of it, that is seen as a major threat to US economic growth and financial stability. Surges in commercial property loans losses have been a common feature of past recessions.
While the Fed did raise its federal funds rate by 25 basis points last month despite the bank failures, it will be acutely aware that more rate rises could tighten credit conditions even more and, coupled with the risk aversion being demonstrated by the regional banks, could tip the commercial property market over the edge.
Its deliberations will be complicated by last week’s US job data, which showed the unemployment rate falling to 3.5 per cent. The only slightly encouraging note in the data was that wages growth seems to be slowing, rising at its lowest rate in nearly three years.
The strong growth in employment doesn’t suggest an economy that is faltering or provide a compelling reason for the Fed to pause or end its rates-hiking, although jobs data is usually a laggard among economic indicators.
The US bond market appears to be pricing in a decision by the Fed to continue to prioritise the fight against inflation, with the Fed perhaps confident that the measures it took to inject liquidity into the banking system last month will be sufficient to render the tighter credit conditions a passing phenomenon.
Bond yields fell sharply in quite volatile conditions after the bank failures. Yields on two-year Treasury notes had been just above 5 per cent at the start of last month, but had fallen to 3.78 per cent early last week, before climbing back to 3.98 per cent at the end of the week as fears of a more systemic issue for banks subsided.
Ten-year bond yields followed a similar but more muted trajectory, resulting in a yield curve that is even more inverted than it was, with three and six months Treasuries trading at yields around 140 basis points higher than those on 10-year bonds.
An inversion of the yield curve, where yields on short-term securities are higher than those on the longer-term issues that ought to carry premia for the risk of holding them much longer, has preceded the past 10 US recessions.
For the moment, at least, equity investors appear less pessimistic about the outlook for interest rates, credit conditions and the economy than their bond market peers.
The US sharemarket has risen about 6 per cent since Silicon Valley Bank fell over. Equity investors appear to be looking for the rate cycle to turn amid a rapidly slowing economy and for the Fed to start cutting rates before the end of the year.
It would be unusual for equity investors to read the economic tea leaves better than bond investors, but they don’t appear to see a deep or lasting recession on the horizon.
Every US inflation print and every Fed rate-setting meeting in this cycle has taken on increasing weight as the Fed moves closer to the point where it breaks the inflation rate, and perhaps the US economy. This week’s CPI data and next months’ Open Market Committee will be no different.
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