Stress in the Banking Sector

2023 has gotten off to a good start, with both stocks and bonds regaining some of the ground lost last year. Continued strength in jobs growth and improvement in inflation data combined to ease investor’s fears that a painful economic recession is inevitable. The bond market, in particular, benefited from expectations of a slowing economy and lower interest rates in the future.

We also experienced an “Out of Nowhere Banking Crisis” during the first quarter. Before this year began, a banking crisis didn’t appear on most people’s list of potential problems for 2023. But in a nervous market, with economic concerns spreading, surprises are not unusual. So, how bad is the banking crisis? As it stands now, the damage is limited to four banks: Silvergate, Silicon Valley Bank (SVB), Signature Bank, and Credit Suisse. It is worth noting that the first three of these, all U.S. banks, were very unusual institutions and not traditional banks. Silvergate and Signature Bank bet heavy on crypto currency, and SVB was almost exclusively tied to the high tech industry and had over 93% of their deposits above the insured FDIC limit, making them more susceptible to a run on their deposits. Credit Suisse has been a mess for years and the only real surprise is that they were able to stay independent this long.

Keep in mind that the problems that caused the banking crisis in 2008 are not causing the issues we are seeing now. So far, these four banks are the extent of the problems. There are always fears that these problems could spread, but we have not seen any contagion as of now. We view this as a Mini Banking Crisis, and not the full-blown melt down we saw back in 2008.

In an attempt to bring inflation down, the Federal Reserve raised the Fed Funds rate twice during the first quarter after eight increases in 2022. They have indicated they are nearing the end of their rate hikes, which is typically good news for the markets. The important question is whether they have raised rates too much, which may result in a severe recession, or if they can reduce inflation without damaging the economy. This is no small task and is very difficult to pull off. It is clear that the Fed is willing to have a recession to get inflation under control. They have admitted to being too slow to raise rates after the pandemic, and it seems likely they will not repeat that mistake.

Bonds are the safer bet this year as interest rates will likely drop as the economy slows, allowing the bond market to gain back some of what was lost in 2022. A reduction in inflation without a recession would likely allow stocks to rally, although a recession, especially a deep one, could cause more equity pain. Right now, it’s impossible to know how it will play out.

Wabash Capital