The Fed finally breaks something … why more pain is coming for the sector … the Fed finds itself in a rock-and-a-hard-place situation … two frustrating details of the SVB collapse

The question was “at what point will the Fed’s historically-fast rate hike campaign break something?”

Apparently, the answer is “now.”

As you’re likely aware, Silicon Valley Bank has failed, and other regional banks, such as First Republic appear to be in trouble.

To understand what’s happening and the potential fallout, let’s go to legendary investor Louis Navellier and this morning’s Platinum Growth Club Special Market Update podcast:

Even though we don’t know exactly what Silicon Valley Bank did wrong, it appears that they had too much money invested in long bonds. And when bond yields went higher, the values dropped, and they got caught with a capital problem.

They’ve been rescued, and this is the right thing to do because if there’s any failure in the banking system, it hurts all banks.

Diving into the details of Louis’ point, late yesterday, the U.S. government announced it would guarantee all deposits at Silicon Valley Bank, which regulators shut down Friday.

Here’s more from The Washington Post:

Officials also revealed that they had shut down a second bank, Signature Bank of New York, and extended the same deposit protections to its customers.

And the Federal Reserve announced it would create a separate lending facility to protect other banks from the ripple effects and prevent bank runs.

And this comes from a joint statement released by the Treasury Department, the Fed, and the Federal Deposit Insurance Corporation:

Today we are taking decisive actions to protect the U.S. economy by strengthening public confidence in our banking system.

Despite this, Louis believes more dominoes will be tipping over.

Additional regional banks will come under pressure

Louis’ expertise on banking toxicity isn’t limited to his multi-decade investment career. He was also a banking regulator in the late 1970s and early 1980s where he used to merge financial institutions so they could qualify for FDIC or FSLIC deposit insurance. So, he’s very familiar with the dynamics that are playing out in front of our eyes today.

Unfortunately, Louis believes more regional banks will tip over. He points toward one such troubled bank – First Republic – noting that JPMorgan has already announced it is stepping in to rescue First Republic.

Louis says we’re going to see more of these troubled regional banks going to the big players as additional Fed-related pain ripples through the banking sector:

The Fed was trying to kill inflation and raise rates, but ironically, they’re killing the banking system. Because as long as that yield curve remains inverted, we’re going to have some more banking issues.

Now, the Fed has opened its deposit window for a full year, up from 90 days. So, banks can get access to emergency funding. But if the Fed really wants to fix everything, they need to un-invert the yield curve, period.

And they can do that with their open market actions.

These open market actions refer to the Fed’s interest rates policy decision, which we’re scheduled to get next Wednesday after the Fed concludes its March meeting.

Less than one week ago, following Federal Reserve Chairman Jerome Powell’s hawkish commentary before Congress, the overwhelming odds were on the Fed raising rates by 50 basis points in March.

But now, in the wake of the Fed finally breaking something (with more shattering appearing likely), those odds haves plummeted – in fact, the odds of a 50-basis-point hike are now clocking in at 0%.

Meanwhile, traders are suddenly putting 35.8% odds on the possibility of the Fed completely pausing rates next week. One week ago, those odds were at 0%.

And that’s not the only sudden reversal we’re seeing in the financial markets…

The bond market has witnessed an historic “about face” in the wake of the banking turmoil

Investors are flooding into the safety of bonds. Given the inverse relationship between bond prices and bond yields, this surging purchase demand is driving bond prices up, which is crashing yields.

The speed at which this is happening is historic.

From CNBC:

The yield on the 2-year Treasury was last trading at 4.06% down 53 basis points. (1 basis point equals 0.01%. Prices move inversely to yields.)

The yield has fallen 100 basis points, or a full percentage point, since Wednesday, marking the largest three-day decline since Oct. 22, 1987, when the yield fell 117 basis points.

That move followed the Oct. 19, 1987, stock market crash — known as “Black Monday” in which the S&P 500 plunged 20% for its worst one-day drop.

The move was bigger than the 2-year yield slide of 63 basis points that took place in three days following the 9/11 attacks.

The yield on the 10-year Treasury was down by close to 21 basis points at 3.477%.

Louis calls the collapse in treasury yields “unprecedented.” He then pivots back toward the primary source of all the chaos, the Fed:

So basically, the Fed has hurt itself. I think they have a lot of soul searching to do right now.

And we’re going to have some inflation news this week with the Consumer Price Index. And a lot of folks aren’t expecting it to be that good.

So, it’ll be interesting to see how the Fed responds to this whole mess it’s created.

The Fed finds itself in a rock-and-a-hard-place conundrum of its own making

Option A – it continues to hike rates as the market anticipated a week ago (50 basis points) to fight stubborn inflation, knowing that it will likely result in additional regional banking failures…

Option B – it slows down rate hikes (25 basis points) to prevent further destabilization in the banking sector, knowing that could leave the door open to a resurgence in inflation…

Is there an Option C? Specifically, the Fed actually pauses rate hikes as a growing number of market participants now believe?

While anything is possible, think about the message that would send to the market.

For months, the Fed has maintained its “higher for longer” position, as well as preparing the market for a higher terminal rate than was anticipated even just a few weeks ago.

And suddenly, it’s going to completely pause rate hikes?

Plus, as we highlighted above, the Treasury Department, Fed, and Federal Deposit Insurance Corporation just released a joint comment that boils down to “relax, we got this.” So, how much confidence would it instill if the Fed suddenly abandons its prior hawkish plans and pauses rate-hikes completely?

I think the message that would send is “we’re scared too, and we aren’t sure how big this is going to be.” I worry that move would result in even greater panic from Wall Street.

Finally, there’s an Option D – the Fed hikes rates 25 basis points, yet delivers an overly-dovish statement. In essence, it tries to save face on the rate-hike front while trying to instill confidence.

It’s unclear how the market would respond. Would it put more weight on the rate hike or the dovish commentary?

I know one thing – I wouldn’t want to be Jerome Powell right now.

In any case, we’ll get another clue tomorrow when we receive the latest inflation data from the Consumer Price Index report.

We’ll keep you updated as this develops.

Before we sign off, two frustrating details in this entire debacle

First, only days before the Silicon Valley Bank collapse, SVB executives sold millions of dollars’ worth of SVB stock. We saw huge sales from the CEO, the General Counsel, the CFO, and the CMO.

So, they pull their money out while the rank-and-file SVB employees wake up a few days later, watching their stock collapsing.

Second, many in the financial press are comparing the SVB collapse to the Lehman Brothers collapse back in 2008.

Well, here’s a fun tidbit…

Before joining SVB as Chief Administrative Officer, Joseph Gentile worked as Chief Financial Officer at Lehman Brothers. Gentile left Lehman in 2007, just one year before it went bankrupt in 2008.

Here are a few reactions to this connection from the Twitter mob:

– “You can’t make this up.”

– “This is truly unusual”

– “It’s all starting to make sense now!”

Have a good evening,

Jeff Remsburg