If there is one certainty to emerge from the spectacular collapse of Silicon Valley Bank which is still triggering shock waves throughout the banking system, it’s that all bets on higher interest rates in the near future are off.
The European Central Bank was due to raise rates by another half a per cent when it meets on Thursday but this now looks highly unlikely. So too does a planned hike by the Federal Reserve which was expected to raise interest rates again by a half a per cent when it meets next week.
Interest rate traders say it’s now almost certain that central bankers will be forced to draw in their horns in their fight against inflation because of the impact that higher interest rates have had on the most vulnerable banks with big bond portfolios.
The latest US futures pricing now suggests there is a 50% chance the Fed will hike borrowing costs by a quarter of a per cent next week, a big shift from only a week ago when the markets were betting on a 50 bps move after the Fed’s chair, Jay Powell, let it be known that aggressive rises were still in the pipeline.
Despite the US administration’s swift action at the weekend to bring stability to the markets by guaranteeing depositors at Silicon Valley Bank and at Signature Bank in New York, investors remain nervous and markets febrile.
Alongside the guarantee, the Federal Reserve has also announced a new Bank Term Funding Program (BTFP) which will provide additional funding by offering loans of up to one year in length to banks, savings associations, credit unions, and other eligible depository institutions pledging US Treasuries, agency debt and mortgage-backed securities, and other qualifying assets as collateral.
These assets will be valued at par – their face value. This has been designed to prevent banks from being forced to sell government bonds that have been losing value due to rising rates. As one banker said about the new scheme: “This is a get out of jail card for all the mainstream banks because they can now value their bond assets at par and not mark to market. And this gets them out of a huge hole which was dug when the Fed jacked up rates so quickly.”
It may well be that other central banks including the Bank of England have to introduce similar schemes to prevent banks from showing big unrealised losses on their balance sheets.
Among the worst hit shares when the markets opened in the US were those of regional banks – the KBW regional banking index fell 11.2%, while the S&P 500 banks index dropped 7.7%. Western Alliance fell a huge 80.6%, First Republic has fallen 67.7% and PacWest Bancorp dropped by 47.7%.
In the US Treasury market, the yield on two-year bonds fell by the most since Black Monday in 1987 while share prices on Wall Street fell across the board.
European bank shares were down to their lowest in more than three months with troubled Credit Suisse falling to a new low. Shares in Italy’s biggest banks, UniCredit and Intesa Sanpaolo- are now down by nearly 10% since news of SVB’s collapse on fears that they are particularly vulnerable because the risk premiums demanded by investors to buy Italian bonds is greater than those paid for on German bonds. Overall Europe’s banking index was down nearly 7%, the worst fall since the outbreak of Russia’s invasion of Ukraine. Even the mighty HSBC – which bought SVB’s UK subsidiary in a late-night rescue deal for £1 – saw its shares drop back.
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