Fed’s SVB dilemma: inflation risk vs. financial stability risk. The fiasco surrounding Silicon Valley Bank (SVB) triggered a classic flight to safety, with equity markets selling down while 2Y US Treasuries rallied as investors priced-in the plausibility of the Fed scaling down (or even pausing) its policy tightening path. This is our take on the situation:
No systemic fallout: As we have opined in Multi-Asset Weekly: All Eyes On SVB Collapse (13 March 2023), we believe that the SVB collapse will not have significant contagion effect on the broader market given that the incident was caused by the unique composition of SVB’s balance sheet rather than systemic liquidity risk.
To recap, SVB held a large proportion of its assets in investments (57%) compared to the average US bank (24%). This outsized exposure to interest rate-sensitive instruments, coupled with the lack of hedging measures, contributed to the erosion of its asset base and subsequent need for fundraising.
Expect near-term volatility to persist among small-to-medium sized US banks. But beyond this initial knee-jerk reaction, clearly, this incident is specific to SVB and has no long-term negative bearings on the broader US Financials sector. Besides, to address liquidity risks, the US regulators have already set up a Bank Term Funding Program (BTFP) to provide additional funding to domestic financial institutions.
Fed’s rethink: The collapse of SVB has shifted the Fed’s attention to rising financial risk in the system after the slew of aggressive rate hikes since last year. This debacle comes at a time when Fed Chair Powell has only recently opined that more aggressive rate hikes are warranted to stem sticky inflation.
The SVB fiasco will certainly cause a rethink among Fed officials, and this is our take on the Fed’s policy path:
Data show that that past bank failures have historically triggered a spreading of risk that forced the Fed to pause policy tightening. We believe that the SVB collapse does not pose systemic risks but it will undoubtedly dull the Fed’s hawkish agenda.
That said, one should also be cognisant that inflation risks remain. Should incoming inflationary data remain sticky, the Fed will still be compelled to act via policy tightening. Taken together, we believe that the Fed will maintain its policy tightening path, but at a less aggressive pace of 25 bps.
Portfolio Implications: Opportune time to deploy cash to quality equities and IG bonds. We believe that the recent market pullback in the wake of the SVB crisis will present an opportunity for investors to deploy cash in quality risk assets:
Equities: We maintain our preference for quality plays – companies with established track records, robust financials, and strong economic moats that can withstand market volatility. A moderation in Fed’s policy tightening path is positive for quality plays in Big Tech.
Credit: Credit spread widening for banks’ capital securities provide a compelling entry point for income investors. Our preference remains towards larger, higher-rated banks globally that are repeat issuers in fixed income markets.
Implications for private markets: manager selection is key. The collapse of SVB will have wider repercussions on the private markets given its role in the VC/PE ecosystem. SVB’s banking propositions targeted early-stage and growth companies and it was widely regarded as a bank specialised in servicing tech companies and start-ups, as reflected in the bank’s deposits and loans composition.
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