After hearing rumors of a "soft landing" from the Federal Reserve for the past year, an old-fashioned bank run has raised the odds considerably of the outcome from its aggressive rate-hike program ushering in a much harder one.
Although Fed Chairman Jerome Powell warned us that the road ahead will be "bumpy" during his testimony before Congress last Tuesday, a bank contagion beginning just a few days later is not what investors had in mind. As I was typing my column last Friday, California banking regulators moved quickly to close Silicon Valley Banking Financial Group (SVB) in what became the second largest bank failure in history.
SVB was one of the leading technology financiers, and its failure showcases potential unintended consequences of the aggressive hiking cycle pursued by the Federal Reserve in its fight against inflation. And once financial panic sets in, the resulting massive withdrawals in other troubled banks threaten to push down bank assets below deposit liabilities, which would wipe out their net worth as well.
With visions of 2008 dancing in citizens’ heads, banks across the U.S. reached out to depositors on Monday to ensure them that their assets are safe after three banks failed last week. The Treasury and Federal Deposit Insurance Corporation (FDIC) issued a joint statement to ensure depositors at regulator seized SVB that their insured deposits would be available on Monday.
To avoid a catastrophic exodus from U.S. banks ala 2008, the Fed immediately announced implementing the Bank Term Funding Program to guarantee deposits. The central bank’s emergency loan program may inject as much as $2 trillion of funds into the U.S. banking system and ease the liquidity crunch, according to JPMorgan Chase & Co. The new Fed program has enough power to reduce the pressing banking reserve issues, but it could also reverse some of the tightening done by the Fed to battle high inflation, JPMorgan said.
Moreover, the banking turmoil spread to Europe on Wednesday, as shares of Credit Suisse — a Swiss bank with extensive U.S. and global operations — tumbled 31% before paring back declines to 20%. This was the biggest one-day selloff on record after the Swiss investment bank's largest shareholder said it was not open to providing further liquidity to the embattled bank. Credit Suisse is having to borrow up to 50 billion Swiss francs, or $53.68 billion, from the Swiss National Bank as its stock plunged amid fears it will default on debt.
With lower prices for financial assets likely being the New Normal, how can solvency be resolved for regional banks with negative liquidity without sharply reducing interest rates to restore the 15-year Zero Interest-Rate Policy (ZIRP)?
Moreover, JP Morgan Chase and other New York banks have tens of trillions of dollar valuations of derivatives, which are gambles on how interest rates, bond prices, stock prices, and other measures will change in future. After fifteen years of ZIRP, these casino bets have reached vast magnitudes beyond what characterized the 2008 crash of AIG and other speculators.
All of this has brought even more uncertainty into the marketplace, as the blackout period for Fed speakers before the central bank’s March 22nd decision on rates has kept traders guessing. Monetary policy expectations have dramatically shifted since the banking contagion began. The general consensus is that rates will still rise, but most are betting on a 25 bps hike next week. While some analysts, such as Goldman Sachs, no longer expect the Fed to raise rates at all.
There was some confidence restored on Thursday after the European Central Bank (ECB) moved forward with its plan to tighten its monetary policies with a 50 basis point across-the-board rate hike. The supersized rate increase means the troubles at Credit Suisse and financial market jitters were not enough for the central bank to back off its inflation fight.
Last week, markets saw a nearly 80% chance that the Federal Reserve would raise interest rates by 50 basis points at the next two meetings. After the ECB decision to raise by 50 bps, markets are pricing a one-and-done Fed hike of 25 basis points next week, and now see the potential for a rate cut by late summer.
Furthermore, the two-year Treasury yield quickly sinking back down below 4% is telling us the Fed may pause either next week, or more likely in May. Billionaire investor and DoubleLine Capital CEO Jeffery Gundlach has consistently mentioned the Fed historically following the 2-year Treasury yield.
The "Bond King" tweeted back in December, "Fed just follows the message of the two-year Treasury yield. You can see that on a chart of the fed funds target rate and the 2-year yield. So who needs the Fed? Why not replace it with the two-year Treasury yield?" The Fed Funds current target rate is at 4.50-4.75%.
The gold price is now rallying again above $1900 as a safe-haven and is reacting to several drivers. The current financial stability risk leading to more government bail-outs, rising interest rates causing the steepest yield curve inversion since 1981 because of smart money running away from the long-term, and a Ukraine war with no end in sight. Oh, and on top of this, we have the ongoing crypto crisis.
Meanwhile, gold stocks are holding up well after already having experienced sector-wide capitulation into late 2022. Although we saw the largest volume spike higher in the GDX on Monday in over a year, while the Gold/S&P500 ratio is on the verge of breaking out, there has been no follow-through buying. Investors are waiting to see how Fed Chairman Jerome Powell maneuvers out of a corner the central bank has painted itself into next Wednesday.
If the world’s most powerful central bank continues hiking interest rates, then they ultimately risk breaking additional things and having investors losing more faith in the financial system. But if the Fed suddenly changes course on rate hikes, that will inevitably lead to deeply entrenched inflation for longer with the Fed having to lift its 2% inflation target.
Gold Futures are in the process of sniffing this dilemma out, as investors are already losing confidence in government and the Fed’s monetary policies. Yet, gold stocks still need to be convinced this will finally be the move that leads to an historic breakout on a monthly/quarterly basis in two weeks above 12-year resistance at $2000 per ounce.
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