The SVB case: a practical guide for small investors
Alberto Matellán, chief economist at MAPFRE Inversión
The ghosts of 2008 have reappeared in recent days, with two consecutive bankruptcies from two US banks. The specific cases of SVB and Signature don’t however seem to be driving a systemic contagion, as before, as the reaction of the US authorities and their particular circumstances would indicate. However, such a scenario cannot be completely discarded yet, and in any case, it clearly shows that the tightening policy of central banks and the reduction of aid by the Federal Reserve has damaged the finance sector. A first lesson, valid for many non-professional investors, is that investment in the banking sector is not limited to “higher rates = good news for banks.” Each bank's stock market analysis is much more complex, starting from the acceptance that what improves their business is a pointed curve (i.e., that longer-term rates are higher than shorter-term rates), not simply higher. In short, as we are seeing, it’s very dangerous if only the short rates rise and the curve inverts.
The most important thing for the future, in my opinion, is not the specific case of SVB itself, but rather how this will impact the Fed's policy, which is ultimately the key to the market today. We mustn’t forget that there is a meeting scheduled for next week.
The immediate reaction is that, again, the central bank provides the necessary liquidity. It’s very likely that this week American banks will make strong use of the liquidity facility with reduced requirements. This is good because, as we saw with UK gilts market last September, it shows that central banks prioritize the stability of the system against dampening rising inflation, at least in the very short term. This reduces tail risk, at least that perceived by the market, and therefore prevents chain reactions.
With regard to rate hikes, it’s likely that a brake will be contemplated. Powell's language last week was really aggressive, which gives him room for maneuver to reduce this tension a little now, even temporarily.
The most important tool currently available is reducing the Fed’s balance sheet, through tightening. But will this be enough to get to the end game? The Fed had said that one of the key variables in stopping that process is bank reserve levels. What the SVB debacle shows us is that the level of these reserves is less important, or at least of the same importance, as the speed at which they are reduced; and this last one has been very fast.
Reducing the balance sheet means reducing liquidity, which in turn curbs inflation. Similarly, it should be considered whether the reduction has already been sufficient when we’re seeing M2 rates (which reflects money in the real economy) in negative territory. In any case, the effect is the same (the variation is as important, or more so, than the level).
The foregoing doesn’t set out a clear response from a technical point of view, but it could make the Fed more prudent, in the sense that even though liquidity restrictions don’t affect all sectors or companies equally, the weakest ones are already very affected and that in itself impacts the entire system. In practice, this would manifest in a halting of the balance sheet reduction in advance of the timeframe anticipated by the market.
The key to finding a response to the reasoning laid out above may be in financial conditions. Only three weeks ago we showed how financial conditions in the US had become very lax, and that justified a new tightening, at least in terms of language. Financial conditions can vary very quickly as the market moves. If this most recent scare has been enough to tighten them strongly again, that could help this situation progress by bringing to a head the end of the balance sheet reductions and/or alleviate the pressure on Fed rates. If this were not the case, the Fed would return to the aggressive trajectory after putting out this fire.
By way of conclusion, I return to my original point, which is to say that stock market analysis of the banking sector is much more complex than it seems at first glance. We have to look at the curve exposure and the balance sheet structure, among other elements, all of which demonstrate, more than ever, the need for active management.
In addition, the probability of a reduction in the Fed's hawkish pressure has increased greatly. If so, and we shall see next week, that could be good news for the market in the coming months, if inflation cooperates. It depends on how financial conditions evolve in the coming days.