Investing Pioneer – 4/12/2023 – 8:22 PM EST
Some have said Quantitative Easing made a comeback in the aftermath of the SBV collapse. Did it?
Federal Reserve data a couple of weeks ago revealed the balance sheet of the Fed rose by 300 billion in response to the bank failures that plagued the month of March. This balance sheet spike garnered a rather significant amount of attention, and some controversy.
Unlike traditional QE, the surge is not a result of the Federal Reserve buying assets, like MBS or treasuries.
Instead, to provide liquidity for banks in need, $148.3 billion was allocated to the discount window. Nearly $12 billion for the new Bank Term Funding program. Lastly, $142.8 was related to banks seized by the FDIC, including SBV, making the total $303 billion.
Rather than the Federal Reserve propping up asset prices by direct purchases (AKA QE) to support banks that hold such assets, they are now simply supplying liquidity for banks if they are in a precarious position (as many are, simply because of rising rates, coupled with unideal or imprudent practices).
This prevents banks from selling securities out of necessity, which would serve as a negative pressure on asset prices and could lead to a cascading effect in the financial system. (Hence the term contagion)
Is it inflationary? Well, it may be anti-deflationary, as it potentially prevents any bank from selling their securities for the purposes of liquidity needs in the short term (largely driven by depositors withdrawing funds because of the spread in interest paid to depositors vs simply holding treasuries or moving money to larger banks as it is perceived as safer as a function of the probability that depositors will be bailed out if it collapses).
George Saravelos of Deutsche Bank called the bailout of SBV depositors a new form of QE.
Nigel Green of DeVere Group said the same.
. . .
What This Means For Interest Rate Changes Going Forward
After Chairman Powell’s perceived hawkish sentiment during his congressional testimony in March, the probability of a 50 bps rate hike at the following meeting became the majority-held consensus. This, in part, precipitated SBV’s collapse.
After these failures, however, the markets have severely downgraded the possibility of a 50 bps hike. Some even say the Fed will now begin cutting rates. As of April 12th, it is now known that the Federal Reserve went for a 25 bps hike.
Therefore, the question must be asked, have the series of events over the past several days revealed new and relevant information to the Fed that tells them to slow, pause, or reduce rates? Have they responded accordingly, with their open discount window (charging 4.5% to banks for fast access to liquidity in an emergency situation), and the new Bank Term Funding Program (which analysts at JP Morgan estimate has the scope to inject up to $2 trillion)?
Principle says that the Fed will likely continue to hike rates, though the probability of a 50 bps hike has likely decreased. Why? Because, to retain credibility, and maintain a solid grasp on inflation, the Federal Reserve, both in their eyes, and the eyes of the markets, can-not soften their interest rate policy.
I think the general theme is as follows: rates will rise or remain high, and liquidity will be provided on an as-needed basis.
Equity markets have signaled that many banks are in poor shape. At least in terms of the probability of future profitability for shareholders. One of the worst cases, Credit Suisse (CS), had fallen over 30% since the beginning of March (as of the writing of this document in mid-late March), and 75% over the past year.
The unrealized losses banks are taking on securities are coming to light. From the consumer side, fear precipitates withdrawals potentially equalling a complete run on the bank. The limit necessary for a bank run to occur is reduced in the context of massive unrealized securities losses, like in the case of SVB.
The WSJ recently reported that a new study by economists showed 186 banks may be prone to similar risks as SVB.
Certainly, this must be the case. In a fractional reserve system, where unsecured deposits are invested in long-term bonds on the bank’s balance sheet when rates rise, losses are incurred, and if the demand for liquidity rises, banks may not be able to shore up the capital of depositors requesting withdrawals.
In the direct aftermath of the SBV collapse, U.S. 6-month treasury yields fell ca 0.6% (from 5.3% to 4.7%).
Meanwhile, gold surpassed $2000 dollars, rising in excess of 6% in a single week.