Less than a week ago, Jerome Powell took center stage in front of Congress to discuss all things inflation and interest rates. Markets did not like the tough-talking tone of Powell as he once again stated his intention to break the back of inflation through the primary means by which the Fed slows the economy, interest rates. Ironically, shortly after he was done speaking all bonds, sans the extreme short end of the curve, rose in price, while the interest rates actually fell. Stated another way, the bond market voted once again that Powell is underestimating just how quickly the economy is slowing, thereby pricing in a much more dovish Fed in the future. Since the bond market is pricing in lower rates in the future, despite the Fed’s higher rates now, the result is what’s called an inverse yield curve.
In short, this means that a person can park money in a bond for 1 year and receive a higher interest rate than if they bought a 10 year bond. If you’re thinking this doesn’t make much sense, you’d be right. Until these last two trading days, it has been a lingering concern but hasn’t really come home to roost.
Before Thursday’s market open, investors got word that Silvergate (SI), a bank primarily involved in the Cryptocurrency space, was going to close down. Since this was a niche bank, serving a very small market, there were few ripple effects, however by mid-afternoon on Thursday, it became clear that this unique bank wasn’t the only financial institution facing problems. A not so little institution, known as Silicon Valley Bank (SIVB), was starting to have liquidity concerns as news began to spread that they had mismanaged their interest rate risk and were seeing a tremendous number of depositors withdraw funds. By Friday afternoon, state regulators in California had forced the bank’s closure with FDIC stepping in to shore up insured deposits.
Questions are now swirling as to what other banks may be facing similar issues and whenever that transpires, investors begin to sell first and ask questions later. The net result is a market decline specifically focused in the banking sector. Safe haven sectors such as Gold and Bonds are trading higher.
I will refrain from passionate opinions regarding our Fed, however there is no question that these financial challenges are the direct result of mass liquidity followed by the fastest tightening of monetary policy we’ve ever seen in American history. Their desire to right the wrongs of their past have a real possibility of overcorrecting far beyond what many hoped would be a soft landing. While our economy continues to enjoy pockets of strength and a robust employment picture, I fear that if they do not begin to soften their stance this too will go by the wayside.
Over the weekend, media outlets will take to selling fear regarding the events of Silicon Bank and paint pictures linking that to 2008 and 2009. While it is still unclear if this is an isolated event, make no mistake, I do not believe this to be anything like the Great Financial Crisis, which evolved into a situation whereby our entire financial system was on the verge of collapse.
The challenges we face at present are a direct result of interest rates not to mass speculation in real estate, mortgage backed securities or rating agency inefficiencies. It will be interesting to see if our Fed continues to remain as hawkish as financial conditions erode. I am not sure how they can.
Despite the volatility, I remain comfortable in our allocations across all portfolios. Just a few weeks ago, at the end of January, it seemed that people were once again starting to run back into the market for fear of missing out. Today, those same people don’t want to touch a stock. The movement between fear and greed is rapid and has historically not been a great way to guide an investment thesis.
I suspect next week volatility will remain, especially as we dissect the CPI report. If we continue lower from here I will view it as an opportunity and wouldn’t hesitate taking advantage. Enjoy your weekend and keep all the headlines in perspective. There isn’t much we haven’t seen and while history doesn’t necessarily repeat, it certainly rhymes.