What the Collapse of Two U.S. Banks Could Mean for Markets

Written by: Kevin McCreadie, CFA®, MBA | AGF

How big of a problem to markets is the collapse of Silicon Valley Bank (SVB) and Signature Bank?

Investors were nervous about market conditions already, so the sudden collapse of both banks only makes them more jittery. Shares in U.S. banks have been hit the hardest by the news – especially regional ones that are similar in size to the two that failed – but the fallout hasn’t been confined to the U.S. banking sector entirely and it’s possible the situation could envelop markets even more broadly depending on how it unfolds from here.

That said, there are good reasons to believe a bigger calamity can be avoided, starting with the swift response by U.S. regulators to protect depositors – both insured and uninsured – of both SVB and Signature. While there is sure to be political backlash from the move, it was paramount to the process of restoring investor confidence that the U.S. Treasury, U.S. Federal Reserve (Fed) and U.S. Federal Deposit Insurance Corp. stepped in jointly when they did.

It’s also important that some of the regional banks now under the gun have shored up their own balance sheets in the wake of the two bank failures. In fact, by tapping sources that include the Fed and some of the country’s largest commercial banks, these smaller lenders are in much better position to weather the current storm should it escalate and lead to more bank runs from here.  

In other words, this doesn’t appear to be another 2008-era financial crisis. In fact, it is a different scenario. The Great Financial Crisis was a crisis of “solvency,” whereby deposits funded assets that were impaired or worthless. This, however, is a “liquidity” crisis. Deposits that sat on bank balance sheets and purchased U.S. Treasury securities are now under water given the swift rise in rates. So, again, a very different scenario. 

What is the impact of these bank collapses to monetary policy going forward?

There’s growing speculation that the Fed will stop raising rates – and even start cutting – because of SVB’s failure, which was, at least in part, the result of interest rates rising too much and too quickly in the first place.

Yet, that could be wishful thinking. While some investors would love to see an end to rate hikes as soon as later this month, the Fed has made it abundantly clear in recent weeks that it believes higher rates are necessary to bring inflation back down to its target level of 2%. And what would happen if the Fed did all of a sudden stop tightening and begin cutting rates? Given the circumstances of the past few days, that might not be such a boon for investors as much as it is a signal of something far riskier at play.

Indeed, while equity markets may press for an immediate rate cut, that would probably materialize only if the current crisis in confidence around the banking sector spreads beyond regional players to the country’s larger banks – something we view as unlikely.  

Either way, markets will remain undoubtedly volatile for as long as there is uncertainty about the Fed’s next move(s) and the overall state of the economy and banking system. As such, investors need to be careful about overreacting to every shift in direction that takes place in this type of environment. When there’s this much tumult, it’s usually better to stay calm.

Related: January Theories Backed by Strong Technicals