The collapse of the SVB forces a rethink on interest rates and hits bank stocks

The failure of Silicon Valley Bank has impacted global markets, with investors scrapping forecasts of further rate hikes and dumping bank stocks around the world.

Treasury bond prices soared on Monday, with two-year US Treasury yields posting their biggest one-day fall since 1987, as fund managers increased bets that the Federal Reserve would leave interest rates unchanged at its next scheduled monetary policy meeting later this month would stabilize the global financial system. As recently as last week, markets were set for another half a percentage point gain.

In the US, the two-year Treasury yield, which moves with interest rate expectations, fell 0.41 percentage point to 4.18 percent. It had previously fallen below 4 percent to its lowest level since September. The benchmark 10-year government bond yield fell 0.22 percentage points to 3.47 percent.

SVB was taken over by regulators last week after customers struggled for their money in the biggest test of the US financial system since the 2008 crisis. On Monday, US President Joe Biden sought to reassure Americans that their money is safe, promising to do “whatever it takes” to protect bank deposits. The Bank of England brokered a deal to sell SVB’s UK arm to HSBC for £1.

Still, bank stocks fell sharply as investors worried about which other institutions could also come under pressure.

In the US, First Republic shares fell 77 percent after being halted 15 times in the first two-and-a-half hours of trading, even as the San Francisco-based bank tried to reassure investors it had $70 billion in untapped liquidity .

The KBW banking index, which includes larger lenders, fell 12 percent shortly after opening, even as the benchmark S&P 500 index of the country’s largest stocks was flat.

Europe’s Stoxx banking index fell 5.6 percent, completing its decline since the middle of last week to just over 11 percent, with all 22 stocks in the index in negative territory. Several lenders suffered double-digit declines on Monday alone, including Spain’s Banco Sabadell and Germany’s Commerzbank. The Austrian Bawag Group lost 8 percent.

The collapse of the SVB and the closure of Signature Bank come just months after the short-lived UK government bond crisis, underscoring the risks lurking in the financial system as central banks quickly raise borrowing costs. Investors and analysts said policymakers must tread carefully when attempting to hose down inflation.

“The SVB situation is a reminder that although the economy has held up so far, the Fed’s rate hikes are having an impact,” said Mark Haefele, chief investment officer at UBS Global Wealth Management, in a note to clients. “Concerns about bank profits and balance sheets are also adding to negative sentiment for . . . stock markets.”

Investors believe the latest developments mean the Fed will ease its rate hike campaign after weeks of debate over whether to opt for a 0.5 or 0.25 percentage point hike after its meeting later this month.

Refinitiv now shows that traders see a 48 percent chance of a quarter point hike and a 52 percent chance of the Fed keeping rates on hold.

Goldman Sachs said on Monday it expects no more hikes at the Fed meeting, which ends on March 22, “given the recent strains in the banking system.”

The shock to the bond markets was significant. Germany’s interest-rate-sensitive two-year bond yield fell 0.48 percentage points to 2.62 percent on Monday as bond markets rallied in response to easing expectations of further increases in borrowing costs. The interest rate has fallen from a 14-year high of 3.3 percent hit last week, showing how much investors have adjusted their interest rate expectations since the collapse of the SVB.

Greg Peters, co-chief investment officer at PGIM Fixed Income, said he believes the rally in government bonds is misplaced. “It’s too big a step. Markets are massively overreacting; They completely forgot about inflation,” he said. “This is a massive head fake.”

But some investors and analysts, including George Saravelos, a strategist at Deutsche Bank, said the Fed’s SVB bailout package, which includes an offer to buy government and mortgage-backed bonds at above-market prices, represents a new form of quantification dar easing – the bond-buying program used by policymakers over the past decade and a half to stabilize the financial system.

“Both the pace and endpoint of the Fed’s rate-hike cycle should come down,” Saravelos said, adding that tightening is now being “intensified due to the stress in the US banking system.”

Rabobank analyst Michael Every said the impact of the Fed’s “bailout of Silicon Valley venture capitalists funding Instagram filters that make cats look like dogs” could be “huge.”

“The Fed is effectively allowing massive easing in financial conditions and rising moral hazard,” he said in a note to clients.

Currencies that perform well in times of stress also rallied. The Japanese yen and Swiss franc both rose more than 1 percent against the dollar.

The rapid collapse of the SVB “reassured market participants that if the Fed continues to hike rates, it will eventually break something,” said Lee Hardman, currency analyst at MUFG.

The bank’s collapse has also “taken the wind out of the US dollar’s sails” by highlighting the risks associated with rising interest rates, Hardman added. A gauge of the dollar’s strength against a basket of six international peers fell 0.6 percent on Monday.

Additional reporting by Martin Arnold in Frankfurt

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