Chances of Interest Rate Cut a Virtual Lock After Collapse of Silicon Valley Bank
Financial Services stocks have been tumbling since Silicon Valley Bank said it was forced to sell securities at a loss to manage lower deposit levels amidst rising interest rates. While the sale only affected those customers who had money in Silicon Valley, the 16th largest bank in the U.S., investors feared that those underlying weaknesses could spill over to other banks.
Why Did Silicon Valley Bank Collapse?
Troubles first emerged at Silicon Valley Bank when it invested in long-dated U.S. government bonds. This includes those backed by mortgages. It’s important to remember that bonds have an inverse relationship with interest rates.
When interest rates rise, bond prices fall. When the U.S. Federal Reserve and other central banks around the world, including the Bank of Canada, started to raise rates to tackle decades-high inflation, Silicon Valley’s bond portfolio began to lose value.
Had Silicon Valley Bank been able to hold those bonds until they mature, it would have received its full capital back. But, economic headwinds—which includes rising interest rates, stubbornly high inflation, and fears of a recession—had a negative impact on technology companies, which started to withdraw their deposits.
Silicon Valley Bank didn’t have enough cash in their vaults to cover the withdrawal. On March 8, it announced it was selling $1.75 billion in stock to raise capital. Saying it didn’t have enough cash on hand created panic and lead to customers withdrawing money in masses.
Where retail banks cater to businesses and households, Silicon Valley Bank caters to the tech industry. Almost half of U.S. venture capital-backed technology and healthcare companies were financed by Silicon Valley Bank. Some of its clients have included Airbnb, Fitbit, Pinterest, Lumu, Square, and Cisco.
Silicon Valley may have fewer clients than larger banks like JPMorgan Chase & Co, but they have much larger accounts. A swift run on withdrawals cobbled the bank.
It took just 48 hours from the time it disclosed its lack of capital for Silicon Valley Bank to collapse. It was the largest bank failure in the U.S. since the global financial crisis.
The big question, of course, is whether Silicon Valley Bank’s vulnerability to rapidly rising interest rates is being felt by other banks that are over-exposed to falling bond prices.
There are some who believe that because Silicon Valley is a regional bank, the broader banking system is not going to fail. At the same time, people also thought the same thing during the sub-prime housing crisis, which eventually led to the global financial crisis.
To help prevent a run on withdraws and potential collapse of the U.S. banking system, U.S. President Biden said that deposits at Silicon Valley will be covered, and the U.S. banking system is safe. Investors are not entirely on board, as financial services stock continue to take a beating.
How Will This Affect Interest Rates?
Global central banks have been raising their interest rates since early 2022 to combat white-hot inflation. The U.S. Federal Reserve has raised its rates from near zero to 4.5%, while the Bank of Canada has raised its key lending rate from 0.25% to 4.25%.
More recently, the Bank of Canada has said it will pause future interest rate hikes while the U.S. Federal Reserve has said additional rate hikes are necessary to get inflation under control. The collapse of Silicon Valley Bank and weakness in corporate balance sheets caused by rising interest rates has put all of that in jeopardy.
A growing number of analysts now believe the Bank of Canada will actually announced a 25 basis point cut when it meets next on April 12. The markets are also pricing in a 50-basis point interest rate cut by this summer.
South of the border, analysts thought the Federal Reserve would announce a 25-basis point interest rate hike when it meets next, but because of the Silicon Valley Bank collapse and stress on the entire banking system, a rate hike is not expected when it meets next on March 22. If anything, some expect the Federal Reserve to announce a cut to interest rates this summer.
Sharp Asset Management for Your Retirement Planning
Silicon Valley Bank collapsed in large part, due to rapidly rising interest rates. Fears that these same hurdles could be undermining other banking stocks has increased the odds that central banks will start to cut their rate hikes. With inflation still hot, interest rate cuts could have a tangible affect on the economy and stock market.
If you live in Toronto or the Greater Toronto Area and are looking for an experienced portfolio management team of CFAs to help with your wealth management and retirement planning, the investment counsellors at Sharp Asset Management can help.
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