Wright Financial Group, LLC

April 2023 Newsletter

Markets End March Flat Despite Volatility Around Bank Failures

March was another active month for the financial markets but, in the end, everything ended up just about where it started. As usual, the mid-month volatility stemmed mainly from questions over whether the Federal Reserve would approve another short-term interest rate hike at their March meeting and, if so, how big a hike. The markets are always volatile ahead of a Fed meeting when the Fed is raising rates, but investors were more worried than usual this time around. Their increased fear stemmed from two high-profile regional bank failures earlier in the month, which triggered waves of media speculation about the possibility of another systemic banking crisis on par with 2008. Were these bank failures isolated incidents or warning signs?

I’ll talk more about that shortly, but let’s take a closer look at the markets first. After a bad February, the S&P 500 was back to just over 4,000 by March 3, and it ended the month just slightly higher. In between, though, it had sunk to 3,855, its lowest level of the year so far.* That was on March 13, about 10 days ahead of the Fed’s next policy meeting, and three days after news broke that Silicon Valley Bank in California had collapsed. While the markets were still processing that news, on March 20 it was announced that Signature Bank in New York had also failed.

It’s not surprising the collapse of any bank would shake up the markets and worry everyday investors. The very term “bank failure” is synonymous with the Financial Crisis, which occurred only 15 years ago. But by the time March ended, much of the fear on Wall Street had subsided, and rightly so. It helped that Fed Chairman Jerome Powell took a more dovish and reassuring tone than usual at the March meeting and raised rates by only another .25%, which was expected. It also helped that the Fed, FDIC, and Treasury Department had already taken action to protect depositors at Silicon Valley Bank, suggesting that those same measures would be taken if other banks should fail in the future. They later took steps to cover Signature Bank depositors as well.** None of this quite amounted to an admission of guilt by the Fed for causing these bank failures, but it might as well have been because they were the cause.


Snowball Effect

Unlike during the Financial Crisis, the bank failures in March weren’t caused by bank customers defaulting on their loans. Instead, they were directly related to the Fed aggressively raising short-term interest rates to fight inflation, which they began doing over a year ago. Raising rates can affect banks in two ways. One involves the yield curve. Banks need a positive sloping yield curve to be profitable, meaning they need long-term rates to be higher than short-term rates. That’s because their profit comes from something called net interest margin, which is determined by the difference between the interest rate they pay to depositors and the rate they charge to lend money. When the Fed raises rates aggressively as they have been, banks must pay more to their depositors over time but they can’t raise the fixed interest rates on the loans in their books. This compresses their net interest margin, and it becomes cost prohibitive for them to lend money.

So, that’s one problem caused by the Fed, but another is that when interest rates go up, bond values go down, and that includes the values on any government bonds, mortgages, or other such securities held by a bank. In theory, this shouldn’t affect banks because they don’t have to account for these bonds and mortgages at market value the way traders and other financial institutions do. Banks can just hold the maturity value on their books. However, if depositors get nervous about these falling values and start pulling their money out, that can lead to panic and a run on the bank. That creates a snowball effect where the bank must start selling their bonds and mortgages at a loss, and when that happens the bank’s collapse is almost inevitable.

This second scenario is exactly what happened at Silicon Valley and Signature Banks. These failures were 100% Fed-induced. Larger banks have not been affected in the same way because they’re more flexible than regional banks and have more ways of making revenue. Regional banks are more limited and therefore more vulnerable in these kinds of situations.


No Cause for Panic

With that said, I don’t think there is much cause for anyone to worry about a full-blown regional banking crisis, and I say that for three reasons. First, the FDIC coverage limit for depositors is $250,000 per bank, and most people are smart enough not to have more than that deposited in any one bank. Second, as I already mentioned, the Fed quickly taking action to protect depositors at Silicon Valley and Signature banks — including those over the FDIC limit — is an implicit guarantee that they’ll do the same for other banks that may fail. And third, because the Fed created this problem they are uniquely well-positioned to control and fix it. It’s the same reason I’m not too concerned about the possibility of a recession later this year. If a recession does hit (which I still think is likely), it will be a recession caused by the Fed, not economic fundamentals, which are still relatively strong. And since the Fed now has plenty of ammo to combat a recession by lowering short-term interest rates again, I’m confident any recession would be minor and short-lived.

So, once again, despite all the drama and volatility surrounding the bank failures, March ended up being fairly flat for the markets, with most indexes ending the month close to where they started it. Most of you will see this “flatness” reflected in your portfolio statements this month. Depending on your holdings, you might find your values down by a half-percent or one percent, or maybe up by about that same amount. Year-to-date — after a good January, a bad February, and a flat March — most of you (again, depending on your specific allocation) should find yourself up by about 4% on average. And, of course, as I always point out, these temporary value fluctuations on paper don’t matter because your interest and dividend return, your income, has remained consistent through all this turmoil, and will continue to do so!



**“SVB, Signature Bank Depositors to Get all Their Money as Fed Moves to Stem Crisis,” Wall Street Journal, March 13, 2023

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