In recent days we saw U.S. regulators take control of nearly USD $175 billion of Silicon Valley Bank’s (SVB) assets and deployed measures to contain the crisis, making this the largest institutional failure since the financial crisis of 2008. Another small U.S. bank (Signature Bank) also collapsed shortly after, thereby sparking concerns of contagion and stability of the U.S. financial system (Source: Reuters). This seismic shock was severe enough to negatively impact Canadian banks and their global peers. Unlike 2008 where bad loans were responsible for the subprime crisis, the ongoing crisis around SVB and other small, regional banks is more about an old-fashioned liquidity crisis and bank run, amplified by bad management, especially around the management of interest-rate risk.
Overall, we think the on-going events around U.S. regional banks are more a sporadic crisis of confidence about the U.S financial system rather than the canary in the coal mine signaling an upcoming banking crisis. In reaction to the distress at small banks, large U.S. banks have attracted billions of new assets in recent days as depositors seek to park their money at sound, and more regulated banking institutions. One of the important lessons of the great financial crisis of 2008-09 has been to make the banking system more resilient to macro-economic stress by ensuring that large financial institutions can sustain macro-economic stress: recessions are rare, but they happen every once in a while, and are a natural part of the economic cycle. Meanwhile, it’s also natural to see bad businesses going down, but markets are always more nervous when they see distress at a financial institution, even when it’s a small one. A similar episode of market stress happened in Canada back in 2017 when Home Capital endured a bank run, dragging with it the entire banking sector of the TSX (Source: CBC).
Implications for Economic Outlook
Implications for Monetary Policy and Fixed Income
Monetary policy has played a pivotal role for financial markets in the past eighteen months and the sudden rise of systemic risk that shook markets is a good reminder of how important the Fed and central bank actions are for financial markets. For fixed-income markets, the impact in the repricing of expectations was most spectacular for the 2-year bond yields of U.S. and Canadian Federal debt, the most sensitive part of the yield curve to monetary policy, as yields fell a cumulative 129 and 82 basis points between March 9 to March 15th, respectively. Not only odds of future rate hikes were shaved, but the timing of rate cuts was also brought forward into 2023, perhaps starting within a few months.
Implications for Asset Allocation
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