By Co-Founder & CIO, Dr. Charles Lieberman
The major run of uninsured depositors that triggered the failures of Silicon Valley Bank and Signature Bank appears over and attention is returning to inflation, tightness in the labor market and Fed policy. It is widely recognized that banks will likely become more conservative in the management of their assets, so lending terms may become more stringent, helping to rein in economic growth and inflation. But how much? Estimates are all over the map and many are politically motivated. This reinforces our judgment that the Fed (and we) must remain data dependent. This is probably good for the equity market, which could benefit from a period without drama. But the next piece of data is coming Friday, with new info on the labor market and wage inflation. There’s never a dull moment in the markets.
It appears the bank run drama is largely over. Some smaller institutions may continue to bleed some deposits to the safe haven of larger institutions, but borrowing from the Fed’s BTFP and discount window is declining already. Investors and analysts have pored over the books of banks and, as expected, no one was even close to taking on the extreme risks of Silicon Bank. While some banks may continue to lose some deposits, the pace of that deposit loss can readily be handled by existing institutional structures.
In the effort to stoke more panic, I was amused to read lots of articles about the book value losses of insurance companies, as if they could also be highly vulnerable. Most life and property and casualty insurance companies have very large bond portfolios and virtually all of them have experienced large declines in the value of their holdings. That’s correct. But no run on deposits is even possible. It is highly doubtful that many holders of life policies will choose to commit suicide in order to force life companies to pay out on their policies. The panic phase is over. Now, we’re into the consequences phase of this event.
Banks will need to pay more interest for deposits than they have, but because of the many aspects of the relationship between banks and depositors, the rise in deposit yields will likely occur gradually. Also, banks are likely to want to hold more floating rate loans rather than securities that can fluctuate so much in value. Or, they may be more inclined to hedge the rate effects on security valuations. But in the immediate term, they may also be more cautious about lending, since they will want to maintain a high level of liquidity, in case deposit outflows resume. (I think another wave of large deposit outflows is unlikely, but people always fight the last war.) So, lending activity will slow and that will inhibit growth. Most likely, the impact will be small.
Nonetheless, the outlook for the economy is even more uncertain. How much of a slowdown in growth will occur because of the Fed’s rate hikes? That’s been hotly debated for some time and the answer is still unclear. Has the Fed done enough to bring inflation down towards its 2% target? I suspect not, but that’s also hotly debated. Will the bank crisis contribute to a slowdown in growth? Yes, for sure. But how much? That’s yet another question that is hotly debated. The truth of the matter is that the range of possible outcomes is sufficiently wide that we just don’t know how this will play out, even though there are plenty of people who are more than willing to forecast one extreme outcome or another. (Some people just want notoriety, not accurate forecasts.) So, we and the Fed must await incoming data to see the consequences of the policy actions and the latest turmoil.
All things considered, the economy appears to have held up remarkably well. Unemployment claims remain quite low. Consumers continue to spend. Hiring demand appears solid. Nothing appears to have fallen over the edge of the cliff. Perhaps these benign conditions will falter, but they haven’t, as yet.
The above suggests that investors must look to incoming data to judge whether any substantial damage has been inflicted on the economy and whether the course for policy change must respond to these new conditions. Everyone has an opinion about whether this will be necessary, but there’s no clear consensus nor any obvious outcome at this time. The monthly data cycle will not allow us to rest for very long. Another employment report is due Friday and additional inflation reports will follow shortly thereafter. If job growth is strong, investors may worry about another rate hike; weak job growth may suggest an impending recession. Both conclusions are likely to be premature. More time and data are needed. And OPEC’s just announced decision to curtail oil production may boost oil prices and inflation, complicating the inflation outlook and the Fed’s policy decision. There’s never a dull moment.
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