Treasury Yields Drop As Regional Banks Show Signs of Stress
Treasury yields dropped precipitously on Friday, but for all the wrong reasons. Several California-based regional banks experienced a sharp drop in equity values as customers withdrew money out of fear the banks may become insolvent. Silicon Valley Bank (SV) was seized as it was forced to liquidate its bond portfolio due to a negative interest rate margin. In basic terms, this means the bank was paying more to depositors than to borrowers. Fear bled over to the First Republic and the Signature Bank as those stocks were down heavily. These episodes are the result of a decades-long easy money cycle that forced banks to buy long-dated bonds as well as lend money at near-zero interest rates. Additional uneasiness surrounds the fact that there’s never just one cockroach in the room – that these banks, unlike the banks of the 2008 Financial Crisis, are heavily regulated. As a result, they were supposed to have ample capital in reserves to protect against stressful scenarios. In the case of SVB, it still failed. Of further concern is the fact that SVB has been the bank to the most coveted part of the economy for the last 10 years. Their technology and their management team were presumed to be world-class. Yesterday I was telling a friend that the last two days were reminiscent of the Bear Sterns collapse. History does not repeat yet it often rhymes. However, to keep this all in perspective, the big money center banks, or more bluntly, the banks that really matter from a systemic standpoint, maintain abundant capital reserves. So, while the SVB collapse is worrisome, I do not believe we are reliving 2008 all over again.
The Jobs Report came in a bit above expectation and wages grew slower. This takes the .50 basis point hike off the table (especially after today’s negative events in the banking sector). The Fed will most likely go .25 basis point at its next two to three meetings as inflation remains a problem but could change quickly. We assume the Fed funds rate to top off at 5.75% to 6.00% before turning the other way. There is a sense of apprehension in the air now and I think consumers, risk-takers, and business owners will continue to hunker down. Perhaps, the Fed’s work of raising rates to slow the economy and encourage a more cautious spending public is now at play. Higher interest rates have already slowed real estate activity by making mortgages unattractive. They’ve also lowered commercial real estate values and are hitting equities now in a meaningful way. The pain of a slowing economy is beginning to take hold.
What are we to do? Business, real estate, and life have cycles. Real estate is in an adjustment phase and prices (as we have reiterated) will need to adjust to the new era of higher interest rates. Anecdotally, many brokers I speak to realize that price reductions will lead to buyers returning to the table. While not great news for sellers, this is the reality of a free marketplace. The good news is the Fed is nearer to the end of the rate hike cycle than the beginning. Once there is consensus on a rate ceiling, the uncertainty of higher interest rates will dissipate, and activity will resume. However, waiting for that time will not be without some additional distress, I am afraid.