ISMS 11: US Banking Crisis and Fed Rate Cut
The post was originally published here.
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Did the Fed finally break something with its aggressive rate rises? I’ve been repeating in my investment strategy that the Fed will eventually break something, and yes, they did. They did.
- Was the collapse of the Silicon Valley Bank the beginning of the 2023 US banking crisis?
- Has quantitative tightening ended?
- Are we in quantitative easing?
- Could this spread throughout the US?
- Or the global banking system?
- Was this caused by the government or the bad behavior of banks?
- Is the dollar going up or down due to what’s happening?
- Could this trigger a much-anticipated recession in America?
- And how does this impact Feds tightening and inflation the Fed is meeting this week?
- Did the Fed finally break something with its aggressive rate rises?
Was the collapse of the Silicon Valley Bank the beginning of the 2023 US banking crisis?
First, we start with the situation of Silicon Valley Bank, which is going bust. In Silicon Valley Bank’s case, first of all, there was a huge influx of deposits into Silicon Valley Bank over the last couple of years, as well as the whole banking sector in the US.
Where did these deposits come from? In the US, those deposits came from the US government pumping money into the hands of individuals and companies through the various and massive stimulus programs during the covid shutdown. Those stimulus packages passed by Congress went into the banks as deposits from individuals and companies.
Consider the fact that most countries around the world couldn’t do this. Thailand where I am right now, there’s no way the government could print all that money because the currency would have collapsed. And therefore, most governments did not have the privilege of having a reserve currency asset and the ability to print as much money as needed. So America is quite unique in this, and that’s one of the reasons why what’s happening in the US is may not spread to such an extent globally.
What did Silicon Valley Bank do when they got all these deposits?
Well, they didn’t have enough loans available to lend this money out. A bank does basically three things with the deposits that it receives: 1) it can hold it as cash, 2) it can buy some security or investment, like a security that could be traded, or 3) the traditional business of a bank, is they lend out money.
Now if they had a lot of opportunities to lend that money out, they would have locked that money up in loans. Now imagine that a bank had 5% cash, 5% securities, and 90% loans. If people wanted to pull their deposits out of the bank, the bank would have 5% of the money available of their total, and then another 5%, they could sell those securities and repay deposits.
Now they could also go to the government to the Fed and borrow some money to repay deposits to prevent a bank run. But it’s not so easy to get out of loans, right? If you’ve lent money to a company and need that money back, you can’t get that. So the loans are very illiquid, but securities are very liquid.
After the 2008 crisis, new regulations tried to force the banks to hold more cash
Now, let’s add that after the 2008 crisis, basically, the US government came up with new regulations that tried to force the banks to hold more cash and more securities, with the idea being that the combination of cash and securities would be highly liquid assets. And basically, the banks would then be able to pay back if any depositors came, they would be able to pay back.
In fact, at the peak liquidity of the banks, you had almost 20% of the US banking sector’s assets in cash and almost 20% in securities. That means almost 40% of the bank’s balance sheet was in highly liquid assets.
Now also what the US government did is they said, look, if you buy US Treasuries, we’ll count them as purely risk-free, meaning that you don’t have to put aside any capital for that. And remember, the US government was borrowing tons of money. So they needed the banks to own these treasuries. So they provide an incentive for the banks to own government securities, knowing that 1) those are risk-free assets, and 2) knowing that the federal government was borrowing a ton of money, and they needed the banks, not just the Fed, to buy those to buy the bonds that the Treasury was issuing.
I thought that US Treasury bonds were risk-free
And now we have all this risk that we’re talking about? Well, where US Treasuries are risk-free is they are credit risk-free. In other words, it’s almost impossible to imagine that the US government wouldn’t print the money needed to pay back the debts that they owe.
Now, when they print money to pay back debts that they owe, of course, they’re devaluing the US dollar, but still, you’re gonna get paid. So when we talk about risk-free, we’re talking about credit risk-free, but that doesn’t mean that they’re not interest rate risk-free. In other words, what does that mean?
Remember that the Treasury rate for a 10-year bond, going back a few years, was about 1%. Imagine a bank buying a huge portfolio of these 1% government bonds. And then, all of a sudden, the Fed starts to raise interest rates.
Let’s say that you own three-year government bonds. And then the Fed starts raising interest rates, and suddenly, someone out in the market could buy a three-year government bond at a, let’s say, 4-5% interest rate. And now you’re holding one that only pays 1%, holy crap; yours is not worth that much compared to others. To get other people to buy the bond you may want to sell, you’ll have to reduce the price. And it’s going to be a price reduction somewhere between 10% and 30, or 40%, depending on the maturity. In this case, we said three-year maturity. And so that means probably a 10 to 20% loss on that bond.
Did the Fed cause this problem?
Well? Yeah, I think so. Basically, what the Fed did is the Fed aggressively raised interest rates, knowing that all the banks were sitting on a large amount of US Treasury bonds. Now, in the case of US Treasury bonds, whenever you own a bond, you’re exposed to interest rate risk. So what is the risk management of a bank?
Well, the risk management of a bank basically looks at all these different risks and says, how do we hedge this particular risk? So technically, the bank’s not really in the business of trying to make a lot of money on this; they’re in the business of raising deposits and lending those out.
So what they want to do is protect the risk on their portfolio so that the value of the bond doesn’t collapse, and then all of a sudden, the bank is wiped out? Well, basically, what happened is that many of them, the larger ones, in particular, did do some hedging to try to cover this risk. Now, in the bank’s financial statements, you can see analysis, the type of analysis that they do, which is looking at interest rate risk, and they basically say if the interest rates go up by 100, or 200, or 300 bps, it would cause this amount of potential interest rate risk.
Now, if you’re holding a bond to maturity, it’s a little bit different, right? Let’s just say that you as an individual bought a US government bond, that’s a 10-year bond, and you’re gonna hold it for 10 years, and it’s earning 1%. Now, if US Treasury bonds, 10-year treasury bonds now are trading at 5%. If you wanted to sell that bond into the market, yes, you’re going to experience a loss because that bond is no longer attractive because it’s only paying 1%. So you got to reduce the price to equalize the return of that bond between this from 1% to 5%.
However, if you say, well, I don’t really care, I bought this bond for 10 years, I’m gonna hold it for 10 years to maturity, then you are not going to experience this risk, or this lower price, in fact, you’re going to get all of your money back. And so when you get all your money back at the end of the 10 years, you have gotten a pure 1% return.
And that’s part of what Silicon Valley Bank had done is that they had put there, the excess liquidity that they had, they had put into held-to-maturity bonds. When you hold to maturity under US accounting rules, you don’t need to account for this interest rate risk, because you’re going to be holding to maturity.
And there’s a lot of debate about if you were to put that security up for sale; that’s called available-for-sale securities. And for that one, you are going to have to mark it to market and say, well, there’s a big loss on this. But if you hold it to maturity, then you don’t have to. Well, also, what you’re doing is you’re not marking it to market through the P&L. You’re marking it to market through the balance sheet and the equity section of the balance sheet.
Silicon Valley Bank received a lot of deposits, they have a lot of customers, and they’re happy with their deposits there. And then something went wrong. And when that one thing went wrong, all of these friends who are all tech startups and tech companies, all of a sudden told each other, hey, take your money out; there’s a risk at Silicon Valley Bank.
And all of a sudden, Silicon Valley Bank had a run on the bank, meaning that its deposits were withdrawn superfast. So they sold their available-for-sale securities first because they’d already marked down the value of those. So they didn’t have any major loss from those.
But then they had to sell their held-to-maturity assets. It is just like if you owned a 10-year bond, you’re not going to sell it, you’re going to hold it for 10 years, but then you have an emergency in your family, and you are forced to sell it.
What is a liquidity event? How does it happen?
This is kind of a liquidity event where you need the liquidity. And what happened is that Silicon Valley Bank had to start taking losses on their held-to-maturity securities. It’s a debate because I know that in the EU and other places, banks are basically required to show the potential losses on their held-to-maturity. Also, there’s other issues about how you hedge that and how you report the hedging on it.
These are remarks by FDIC Chairman Mark Martin Greenberg at the Institute of international bankers. And he gave this presentation on March 6, so before Silicon Valley Bank collapse happened, and what did he say? I think the most important thing that he said is the following.
“The current interest rate environment has had dramatic effects on the profitability and risk profile of banks’ funding and investment strategies. First, as a result of the higher interest rates, longer term maturity assets acquired by banks when interest rates were lower are now worth less than their face values. The result is that most banks have some amount of unrealized losses on securities. The total of these unrealized losses, including securities that are available for sale or held to maturity, was about $620 billion at yearend 2022. Unrealized losses on securities have meaningfully reduced the reported equity capital of the banking industry.”
Then on March 12, there was a joint statement by the Treasury of Federal Reserve and FDIC, which means Janet Yellen and Jerome Powell and FDIC Chairman Martin Greenberg. So just six days later, they said to take decisive action. I’m quoting from the the announcement,
“Today we are taking decisive actions to protect the US economy by strengthening public confidence in our banking system. This step will ensure that the US banking system continues to perform its vital roles of protecting deposits and providing access to credit to households and businesses in a manner that promotes strong and sustainable economic growth.
After receiving a recommendation from the boards of the FDIC and the Federal Reserve, and consulting with the President, Secretary Yellen approved actions enabling the FDIC to complete its resolution of Silicon Valley Bank, Santa Clara, California, in a manner that fully protects all depositors. Depositors will have access to all of their money starting Monday, March 13. No losses associated with the resolution of Silicon Valley Bank will be borne by the taxpayer.
We are also announcing a similar systemic risk exception for Signature Bank, New York, New York, which was closed today by its state chartering authority. All depositors of this institution will be made whole. As with the resolution of Silicon Valley Bank, no losses will be borne by the taxpayer.
Shareholders and certain unsecured debtholders will not be protected. Senior management has also been removed. Any losses to the Deposit Insurance Fund to support uninsured depositors will be recovered by a special assessment on banks, as required by law.”
Everything that the federal government does is supported by taxpayers
Of course, everything that the federal government does is supported by taxpayers. And the result of this is that if they say that this money is coming out of a fund, the banks have contributed to the other banks, belt, also, that comes from the back of the taxpayers. So what we have here is the Fed coming in, and the Treasury and the FDIC, and basically saying, everybody’s gonna get their money back.
Now, this is a big problem. Why is this a problem? Because only a small number of depositors at Silicon Valley Bank were actually guaranteed by the FDIC. And yet here we have a blanket guarantee. And this is a particularly big moral hazard. Now, some people would say, well, you have to do that; otherwise, money’s going to come out of every bank. They’re going to move money, either home and put it under their mattress, or they’re going to go and put their money into a bigger bank that they trust more.
The Fed knows that other banks are sitting on unrealized losses related to their bond portfolio of US Treasury bonds because they’re holding 1% yielding bonds, and the Fed has increased interest rates up to almost 5%. And the result of that is that they have massive unrealized losses.
We’ve seen the chairman of the FDIC say those losses amounted to about $620 billion in his estimate at the end of 2022. Just imagine that there’s probably more that come out, you know, from under the woodwork.
Also on March 12, the Federal Reserve Board announced it will make available additional funding to eligible depository institutions to help assure banks have the ability to meet the needs of all their depositors. Okay, so this is where the government comes in and says we’re going to protect the whole system.
How are we going to do that?
The Bank Term Funding Program (BTFP)
“The Fed set up a new borrowing facility, the Bank Term Funding Program (BTFP) offering loans of up to one year in length to banks, savings associations, credit unions and other eligible depository institutions, pledging US Treasuries, agency debt and mortgage-backed securities, and other qualifying assets as collateral. The Fund has $125 billion (bn) and it can borrow another $100 bn from Treasury.
The assets will be valued at par, so that banks won’t have to sell US treasuries at a loss in order to redeem deposits as was the case for SVB.”
So the fund can borrow 100-125 billion and another 100 billion from the Treasury. But the kicker is, remember, all of these unrealized losses are because the value of those bonds that were yielding 1% has collapsed. And those bonds now are maybe 20-30% down in price. They say the assets will be valued at par so that banks won’t have to sell US Treasuries at a loss to redeemed deposit. As was the case with Silicon Valley Bank.
Okay, so let’s talk about this for a second. What did they do? First, they gave kind of an implicit guarantee of all deposits at Silicon Valley Bank. And then the next thing they did is they said, if any other bank is facing this problem, and you’ve got massive losses, good news, we’ll help you hide those losses. We’ll hold those losses for year off your balance sheet. This is a very sneaky way of basically trying to prevent losses from hitting the balance sheets of the banks and collapsing the whole system.
Fed will hold the losses for banks at risk
Now what’s happening is all of these small and midsize and regional banks, remember, America has almost 5,000 banks, all of these guys are facing deposit outflows. The result of those deposit outflows are that they have to sell government securities. And suppose they have to sell those government securities at a loss. In that case, it’s going to crush their capital, and all of a sudden, you’re gonna have hundreds, if not thousands of banks, that could be in a difficult situation as far as capital is concerned.
So instead of that, what they’re basically saying is all you guys can come to the Fed. And you can pledge that security at 100%. We’ll hold those losses for a year, and at the end of the year, we’ll figure out what we’re going to do.
Is this quantitative easing (QE)?
Well, there are some people that say that this is not quantitative easing because it’s a swap so that it’s just one asset on the balance sheet of that now has been swapped out as cash. So technically, you could say that when you’re swapping assets with the central bank, it’s not really QE.
However, a second reason why people say that it may not be QE is because it’s also a short-term situation where in one year, those assets are going to go right back, and the losses are going to go on to the bank’s balance sheets.
Well, come on, you think that the Fed, if things go bad, a year from now, they’re going to force all the banks handle the losses?
One of the best ways to understand this, is just look at the assets of the balance sheet. Remember, that for the past year or so the central bank of the US, the Fed has been telling us that they’re doing quantitative tightening, and quantitative tightening means they’re reducing the size of their balance sheet. And also quantitative tightening has to do with, you know, increasing interest rates.
From my experience and what I’ve seen in the banking system, as well as with the Fed, my prediction is quantitative tightening won’t last for long; eventually, quantitative easing will come back. Why?
Because now, the US is in such a situation where it just can’t bear pain. Politicians can’t bear pain. Individuals can’t bear pain. And if you’re bringing pain upon the system, you’re gonna get voted out of office. Why let them bear pain when you can solve this problem?
And that’s one of the reasons why looking at the repeated times that the Fed tried to get off quantitative tightening and to quantitative easing. They wanted to do quantitative tightening but every time they did it, they barely did it. And then eventually, they had to reverse it. And they had to go back to quantitative easing.
So to answer the question that I asked at the beginning, is this the end of quantitative tightening and the beginning of QE? Yes, it is. How do I know? Because the assets of the balance sheet or the assets of the Fed just increased after roughly a year of small decreases? It increased by nearly $300 billion as a result of them providing funding and buying the assets from the bank. So the answer to that question is yes, we are now in QE5; how long it will last?
11 banks announce $30 million in deposits into First Republic Bank
“Washington, DC — The following statement was released by Secretary of the Treasury Janet L. Yellen, Federal Reserve Board Chair Jerome H. Powell, FDIC Chairman Martin J. Gruenberg, and Acting Comptroller of the Currency Michael J. Hsu:
Today, 11 banks announced $30 billion in deposits into First Republic Bank. This show of support by a group of large banks is most welcome, and demonstrates the resilience of the banking system.”
Okay, so basically, they encouraged the banks to provide deposits at First Republic Bank because deposits were running out by individuals. And so these big banks basically said, we’re going to come in, and we’re going to support this bank. Now, you can’t do that with all banks in the system. But on a case-by-case basis, they were able to do that.
Is Warren Buffett going to save the US banking system?
But now, with more banks facing trouble, it brings up a whole other challenge. This is where rumors started swirling about Warren Buffett. Some people on Twitter were tracking these private jets coming to Omaha. Maybe they were gonna see Warren Buffett, maybe Warren Buffett would take a stake in the banking system? Well, it’s very possible.
If you recall, during the 2008 crisis, Goldman Sachs was about to go bust. And they did two things that really helped them stay alive. The first thing was a little bit of a trick. Goldman Sachs is not a depository type of bank taking deposits. But the Treasury Department, which was led by a former Goldman Sachs leader, let Goldman Sachs call itself a bank, and all of a sudden, that meant that they had deposit insurance guarantees. And that was one thing that helped Goldman Sachs to survive. The second one is that I believe, I don’t remember the full details, but I believe that they issued a bond to Warren Buffett, earning a high yield and guaranteed the bond by the assets of Goldman Sachs.
So it’s possible right now that something’s going on. And let’s say Warren Buffett says, I’ll put in, let’s say $50 billion into the 10 largest regional banks, but I need a guarantee from the government that that money is going to be paid back, and I need a guarantee from those banks, that money is going to get paid back. And I’m going to charge a high interest rate, let’s say 8%, something like that.
If Warren Buffett could lock in an 8% return for 10 years, and he could do that with $50 to $100 billion, he’s got plenty of cash to do that. It could be his final move to his legacy by locking in an 8% return that’s almost guaranteed by the government. What a remarkable thing that he could do with that.
So my prediction is that something like that probably will happen, he may even say that, well, even more significant, I want these 10 regional banks, I want them all to combine into one. And then you create one massive bank, and he makes a huge return, let’s say he also maybe wants equity. So he may say, I’m gonna do a convertible bond, and you’re gonna pay a high interest rate on that convertible bond, let’s say 4-8%. And I’m gonna be able to convert the bond into the shares of these individual banks, or of one conglomerate bank that they make out of it. And I’m going to be able to do that at a certain price. That’s going to allow me to make an upside there.
In the end, if he links it together with some equity, instead of an 8% fixed return, let’s say he may end up with a 15 or 20% return as these banks survive. And so the end result is that I think it’s very possible. Buffett, he’s the only one probably that’s got that much cash to do a deal.
Is the Fed going to keep raising interest rates?
Now, it’s important to remember that also, this brings us to the next thing, which is the Fed meeting that’s happening this week. So is the Fed going to keep raising rates? Well, two weeks ago or so, people expected that the Fed was going to increase interest rates by 50 basis points. And now people are expecting about 25 basis points, but the Fed may say, that’s it; we’re not increasing rates anymore. Or there is even a slight possibility the Fed says we’re cutting interest rates, boom! I mean, nobody’s predicting that.
But why would that be an important thing to do all of a sudden? The losses on those bond portfolios. That are there, because the Fed increased interest rates so fast. If you lower interest rates today, the losses on the performance portfolios fall. Remember, we heard from the head of the FDIC, that those losses were $620 billion, that $620 billion could go to $400 billion just like that, if they immediately lowered interest rates.
Or let’s just say that the Fed says we’re not going to lower interest rates, but we’re not going to increase interest rates, meaning we’re at the end of our tightening cycle, and inflation has come down. We’re okay with that. And if they do that, then the next question is, over the next 12 months, will the Fed decrease interest rates? Well, I think you’re running into a real risk that we’re facing a recession in the US.
Is the US facing a recession?
And that brings me to one of the questions I asked at the beginning of this is, are we facing a recession? And I think the answer is yes, the US in particular, is heading into a recession. We’ve had an inverted yield curve, which is one of the best predictors of it. And that inverted yield curve has been telling us that there’s a recession coming in the middle of 2023. And I think there’s every reason to believe that that’s going to be happening.
Now you may say, well, Andrew, unemployment really low and all that. Keep in mind that’s like at a peak, and just as unemployment peaks is the time that we then move into a recession. So a very, very low unemployment rate is actually a sign that we are heading into a recession.
So the answer to the question about if there is a recession coming in 2023? I think yes. And I think also, we’re going to have some serious bank problems.
But this comes to an interesting idea of ethics and insider trading. Suppose the Fed is buying assets, or making deals with someone like Buffett, that he can buy the bank’s assets, and the Fed knows that they could be reducing interest rates, or just that the Fed does reduce interest rates, all of a sudden. In that case, you are buying assets or encouraging others to buy assets that you know are going to increase in value because interest rates are going to come down. Is that insider trading?
That’s a question that I think needs to be asked.
How does this affect the global banking system?
And now, I want to get into the final part of this, which is talking about how does this affect the global banking system?
Remember, I talked about a snake eating a huge animal and watching that move through the snake? Well, that’s what was happening with the US government giving out a tremendous amount of money out to businesses and to individuals. And that money went into the banking system, and bank deposits increased massively during that time. This did not happen in most other countries around the world.
Even in Europe, what we saw was that the government basically provided funding to companies to keep people employed. So it wasn’t a surge in the deposits. And so I would say the first thing is that banks around the world are not dealing with a huge amount of deposits like Silicon Valley Bank was, as well as the US banking system. So that’s good news. In addition, many of the other central banks never printed a lot of money. And so they never had a liquidity situation like the US had.
Is the US dollar going up or down?
However, the next question that I want to try to answer is, is the US dollar going up or down? Well, this, I think, started to relate to the statement that was made on March 19.
“Coordinated central bank action to enhance the provision of US dollar liquidity
The Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank, the Federal Reserve, and the Swiss National Bank are today announcing a coordinated action to enhance the provision of liquidity via the standing US dollar liquidity swap line arrangements.
To improve the swap lines’ effectiveness in providing US dollar funding, the central banks currently offering US dollar operations have agreed to increase the frequency of 7-day maturity operations from weekly to daily. These daily operations will commence on Monday, March 20, 2023, and will continue at least through the end of April.
The network of swap lines among these central banks is a set of available standing facilities and serve as an important liquidity backstop to ease strains in global funding markets, thereby helping to mitigate the effects of such strains on the supply of credit to households and businesses.”
Basically, what’s happening is that people are rushing into the US dollar, they’re rushing into government treasuries, and the result is a squeeze in the Eurodollar market. Many businesses and banks throughout the world are trading in dollars and doing loans and swap agreements and all kinds of things in US dollars. The US government and the Federal Reserve are basically saying we are prepared to provide all the dollars necessary.
They’ve done this before when we faced a crisis and a tightening in US dollar liquidity. So when US dollar liquidity is so tight, and people are concerned, they’re scared, maybe the economies are doing poorly, what’s happening is, there’s a rush to US dollars. And this is saying; we’re going to deal with this by ensuring that those US dollars are available.
That’s part of the problem that the US faces as a reserve currency is that they not only have to deal with liquidity that they have to provide of US dollars in the domestic market, but they also have to deal with that in the international markets.
Could this be a global banking crisis?
And so this tries to answer the question that I was asking at the top, which is, you know, could this spread to countries around the world? Well, I would say, based upon the fact that other banks from around the world did not get such a boom in deposits as happened in the US because the US government could spend a tremendous amount in stimulus, we have less of that. So they definitely have less of that liquidity problem.
But still, interest rates have been rising around the world; the US was the most aggressive in those interest rate hikes. But basically, what you’re seeing is that there are pressures facing all the other banks around the world, but particularly, let’s say in Europe. And so the result of that is it definitely we’re starting to see some strains.
And that brings us to what happened with Credit Suisse. Over the last week or so, Credit Suisse started struggling. They weren’t able to raise additional capital, and now, UBS appears to be ready to buy Credit Suisse. But you can imagine that UBS is not going to buy Credit Suisse unless they get some guarantee from the government. And so I’m sure that that’s the negotiation that’s going on right now.
Again, whenever a banking crisis happens, the regulators and the government want banks to merge. So that raises another question, which is, is this a new banking crisis? Is it in the US, but is it globally? I would say this is a US banking crisis.
What happens if the Fed reverses quantitative easing?
This banking crisis could be the thing that leads us into a deeper recession. But also, one of the interesting things is that this could force the Fed to reverse quantitative tightening and shift to quantitative easing. Remember, I talked about the idea that they could reduce the interest rate at this Fed meeting by 100 basis points, or the next one, or the next one and do an emergency reduction?
Every time we see a crisis happening in the US, What do they do? It’s like trying to take a heroin addict off of heroin. It’s really good to take them off of heroin, but when you see them suffering, the pain of withdrawal, them screaming for that heroin, most people are going to give it to them. And so that’s what the Fed does every time the US faces a crisis. And they lower the interest rate back down to zero.
So I think it’s very, very possible that we could see that the Fed starts decreasing interest rates. They’ve broken something; they’ve broken the banking system with a massive rise in interest rates. And all of a sudden, they’re going to have to reverse and lower interest rates. And we could even see interest rates go to zero in the next couple of months; there is a very high likelihood of that happening.
It’s not what the Fed wants, but they may not have a choice. In this case, if the interest rates on the Fed went down by 100-300 basis points or went down to zero, all of a sudden, the unrealized losses on the balance sheets of the banks gone. Hey, problem solved. We just lowered rates again.
Well, basically now we’re back down to another decade, possibly of zero interest rates, and all kinds of problems that causes. But I think that that is a very real possibility. And the end result of that, of course, is what happens when interest rates go down. Well, the losses on the bond portfolios basically reduce and the problem kind of goes away.
What happens to the stock market?
So we have the potential even though we’re going into a potential recession, stock markets are already down, it could go down further, but if the Fed announces that they’re going to start cutting rates or people start to anticipate that and eventually they do, that tends to be positive for the stock market.
So it’s possible that we could have a big bounce in the stock market. And you could even argue that the financial sector could be the best-performing sector because, they’ve already been knocked down, the weakest ones have been hit, and the sector is down because everybody’s terrified. But if the Fed reversed its policy and started to reduce interest rates, we can see that these banks are going to survive.
And so if that were the case, then you could say that the Financials could be a leading performing sector in the overall market.
Let’s wrap up and answer the questions
Is this the new banking crisis that the Fed causes? Yes, it is. And yes, the Fed caused it.
Has QT ended? Yes, QT has ended.
Are we in QE5? Yes, we’ve started expanding the balance sheet of the bank of the Fed. And if they start lowering interest rates, we are definitely moving into QE5.
Could this spread throughout the US? Definitely, I think it can spread throughout the US, particularly if the Fed keeps interest rates high; we’re going to see more challenges in the banking sector.
And could it spread globally? I would say less so globally because they haven’t had such a boost in deposits from government stimulus. It’s countries like Thailand, where I am, the government could not have printed that much money and then put it in the hands of businesses and individuals, or otherwise the currency would have been crushed. The US Dollar didn’t get crushed, because it is the reserve currency. So they have a privilege.
Was this caused by the government or bad behavior by banks? Well, I would say it’s mainly caused by the government; they kept interest rates low for more than a decade. And then, all of a sudden, they almost instantly raised interest rates from close to zero to 5%. And then they thought that they were not going to break anything; but of course, things are going to break in that case. So I would say, the government caused it from the beginning. And when they tried to solve inflation, they raised rates, and now they’ve caused it again.
And also, you can blame the banks. If banks weren’t properly hedged for interest rate risk, meaning that interest rates would rise and the value of their portfolios would fall, then they’re also at fault. And they should suffer, not be bailed out.
Now is the dollar going up? I think what you can see is that it’s probably likely that the dollar is going to be strong during this time because we’ve already seen in the March 19 announcement that they’re providing dollar liquidity, which means the dollar market is tight. So, therefore, potentially strong dollar.
Could this trigger a much-anticipated recession? Absolutely. I think that this is really messing up businesses and businesses’ access to capital. And already, there’s a lot of fear out there. I think that the US recession is going to happen in the next few months.
How does this impact fed tightening and inflation? I would argue that US inflation is already on a trajectory to be down at about 4% by the end of 2023. From as high as around 7%. But basically, what I think is they’re done tightening relative to inflation. And we could even see a surprise announcement from the Fed this time or next time they meet, or an emergency meeting, that they’re cutting the Fed funds rate by 100 basis points.
Did the Fed finally break something with its aggressive rate rises? I’ve been repeating in my investment strategy that the Fed will eventually break something, and yes, they did. They did.