Gold jumped on US regional/SVB bank crisis; but Dow slips

Gold surged, USD and Wall Street Futures slumped early Monday despite a softer U.S. NFP job report as banks & financials plunged on the concern of the spillover effect of the startup/MSME funding bank SVB (Silicon Valley Bank). On Friday, the California-based bank has been closed by the Federal Deposit Insurance Corporation (FDIC) which has taken control of its deposits. Earlier, the run-on deposits doomed the tech/start-up-focused local lender’s share sale to shore up its balance sheet amid losses from the HTM bond portfolio (mainly MBS) on higher Fed reverse repo rate. Unable to raise fresh funds, the SVB promoter was also looking for selling the bank but failed.

Eventually, after a hectic weekend effort to stabilize the global financial market before Monday's Asian session opening, U.S. Treasury, Fed and FDIC made a joint statement assuring all depositors irrespective of insured/uninsured will be safe and can access/withdraw their deposits/hard earned money; i.e. U.S. government effectively treating SVB and other regional banks as too big to fall and virtually issued Federal guarantee to ensure financial (Wall Street) stability.

Fed is effectively extending unlimited liquidity (by printing more & more) at a time when it’s itself suffering huge negative cash flow to the tune of almost -$1.1T; in his recent Congressional testimony, Fed Chair Powell admitted -$36B MTM loss (unrealized) due to higher reverse repo rate (overnight) to banks. Big U.S. banks are earning risk-free returns equivalent to $36B from Fed as Fed is absorbing excess banking/money market liquidity instead of collateral of US TSYs.

March 12, 2023: Federal Reserve Board announces 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

“To support American businesses and households, the Federal Reserve Board on Sunday 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. This action will bolster the capacity of the banking system to safeguard deposits and ensure the ongoing provision of money and credit to the economy. The Federal Reserve is prepared to address any liquidity pressures that may arise.

The additional funding will be made available through the creation of a new 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 U.S. Treasuries, agency debt and mortgage-backed securities, and other qualifying assets as collateral. These assets will be valued at par. The BTFP will be an additional source of liquidity against high-quality securities, eliminating an institution's need to quickly sell those securities in times of stress.

With the approval of the Treasury Secretary, the Department of the Treasury will make available up to $25 billion from the Exchange Stabilization Fund as a backstop for the BTFP. The Federal Reserve does not anticipate that it will be necessary to draw on these backstop funds.

After receiving a recommendation from the boards of the Federal Deposit Insurance Corporation (FDIC) and the Federal Reserve, Treasury Secretary Yellen, after consultation with the President, approved actions to enable the FDIC to complete its resolutions of Silicon Valley Bank and Signature Bank in a manner that fully protects all depositors, both insured and uninsured. These actions will reduce stress across the financial system, support financial stability and minimize any impact on businesses, households, taxpayers, and the broader economy.

The Board is carefully monitoring developments in financial markets. The capital and liquidity positions of the U.S. banking system are strong and the U.S. financial system is resilient.

Depository institutions may obtain liquidity against a wide range of collateral through the discount window, which remains open and available. In addition, the discount window will apply the same margins used for the securities eligible for the BTFP, further increasing the lendable value at the window.

The Board is closely monitoring conditions across the financial system and is prepared to use its full range of tools to support households and businesses, and will take additional steps as appropriate.

Joint Statement by Treasury, Federal Reserve, and FDIC-Department of the Treasury; Board of Governors of the Federal Reserve System; Federal Deposit Insurance Corporation

The following statement was released by Secretary of the Treasury Janet L. Yellen, Federal Reserve Board Chair Jerome H. Powell, and FDIC Chairman Martin J. Gruenberg:

Today we are taking decisive actions to protect the U.S. economy by strengthening public confidence in our banking system. This step will ensure that the U.S. banking system continues to perform its vital role 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.

Finally, the Federal Reserve Board on Sunday 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.

The U.S. banking system remains resilient and on a solid foundation, in large part due to reforms that were made after the financial crisis that ensured better safeguards for the banking industry. Those reforms combined with today's actions demonstrate our commitment to taking the necessary steps to ensure that depositors' savings remain safe.

Meanwhile, HSBC has bought a U.K. subsidiary of SVB for a token amount of £1, while the intense U.S. effort to sell failed so far. HSBC may inject £2B into the UK arm of SVB.

There is a huge mismatch in assets & liabilities for regional/community banks like SVB.

If we only consider deposits, SVB used to lend around 57% of total deposits, while utilizing 52% on debt/bond (mainly TSYs) investments. But after COVID (2020) this ratio drastically changed; now SVB lends around 43% of the deposit while using 72% on investments/bonds in 2022, against 35% and 71% respectively in 2021. Now as Fed is hiking rates from March’21 and tightening from late 2020 (QE stopped), 2YUS bond prices tumbled from around 110 in Jan’21 to 100 today (13th Mar’23). This 10% fall in bond prices caused a huge notional MTM loss in SVB’s bond portfolio running into billions of dollars. But as most of it falls under HTM (Hold Till Maturity) category, the bank has not considered the MTM (unrealized) loss in its PL account.

But sensing possible loss in the future and liquidity issues, big depositors like VC, start-ups which earlier deposited their excess cash for a better return, are now worried about the return of capital rather than return on capital, causing a run on bank (deposit withdrawal). Thus SVB falls into a liquidity crisis and attempted to raise fresh capital by FPO/fresh bond issuance, but it failed-resulting in the crash. Now Fed is extending unlimited liquidity to such regional community/small banks (like SVB) so that they don’t have to sell bonds/TSYs/MBS in loss to meet withdrawal pressure.

Overall, it seems that these small banks are reluctant to expand their lending business into the productive sector of the economy, which is the core function of any bank. Moreover, SVB lends mainly to local industry like Vineyard; thus there was some limitation. In any way, NIM and NII are bound to suffer for such regional community banks, lending mainly to SMEs. It also seems that the investment arm of such banks is not smart enough to manage bond portfolios effectively. But these banks are also important systematically and politically. Thus White House has no option but to bail out.

On Sunday, U.S. President Biden tweeted: “At my direction, @SecYellen and my National Economic Council Director worked with banking regulators to address problems at Silicon Valley Bank and Signature Bank. I’m pleased they reached a solution that protects workers, small businesses, taxpayers, and our financial system. The American people and American businesses can have confidence that their bank deposits will be there when they need them. I’m firmly committed to holding those responsible for this mess fully accountable and to continuing our efforts to strengthen oversight and regulation of larger banks so that we are not in this position again. I’ll have more to say on this tomorrow morning.”

On Monday, Biden said: Before I leave for California, I want to briefly speak about what’s happening to Silicon Valley Bank and Signature Bank. Before I leave for California, I want to briefly speak about what’s happening to Silicon Valley Bank and Signature Bank.  Today, thanks to the quick action of my administration over the past few days, Americans can have confidence that the banking system is safe.  Your deposits will be there when you need them.

 Small businesses across the country that had deposit accounts at these banks can breathe easier knowing they’ll be able to pay their workers and pay their bills.  And their hardworking employees can breathe easier as well.

 Last week, when we learned of the problems of the banks and the impact they could have on jobs, some small businesses, and the banking system overall, I instructed my team to act quickly to protect these interests.  They have done that.  They have done that.

 On Friday, the government regulator in charge, the FDIC, took control of Silicon Valley Bank’s assets.  And over the weekend, it took control of Signature Bank’s assets. Treasury Secretary Yellen and a team of banking regulators have taken action — immediate action.  And here are the highlights:

 First, all customers who had deposits in these banks can rest assured — I want to — rest assured they’ll be protected and they’ll have access to their money as of today.  That includes small businesses across the country that banked there and need to make payroll, pay their bills, and stay open for business.

 No losses will be — and I want — this is an important point — no losses will be borne by the taxpayers.  Let me repeat that: No losses will be borne by the taxpayers.  Instead, the money will come from the fees that banks pay into the Deposit Insurance Fund.

 Because of the actions of that — because of the actions that our regulators have already taken, every American should feel confident that their deposits will be there if and when they need them.

Second, the management of these banks will be fired.  If the bank is taken over by FDIC, the people running the bank should not work there anymore.

Third, investors in the banks will not be protected.  They knowingly took a risk and when the risk didn’t pay off, investors lose their money.  That’s how capitalism works.

And fourth, there are important questions of how these banks got into these circumstances in the first place.  We must get the full accounting of what happened and why those responsible can be held accountable.  In my administration, no one, in my view — no one is above the law.

And finally, we must reduce the risks of this happening again.  During the Obama-Biden administration, we put in place tough requirements on banks like Silicon Valley Bank and Signature Bank, including the Dodd-Frank Law, to make sure the crisis we saw in 2008 would not happen again.

 Unfortunately, the last administration rolled back some of these requirements.  I’m going to ask Congress and the banking regulators to strengthen the rules for banks to make it less likely that this kind of bank failure will happen again and to protect American jobs and small businesses.

Look, the bottom line is this: Americans can rest assured that our banking system is safe.  Your deposits are safe. Let me also assure you: We will not stop at this.  We’ll do whatever is needed on top of all this.

Let’s also take a look — a moment to put the situation in a broader context.  We have made strong economic progress in the past two years.  We’ve created more than 12 million new jobs — more jobs in two years than any President has ever created in a single four-year term.  Unemployment is below 4 percent for 14 straight months.  Take-home pay for workers is going up, especially for lower- and middle-income workers.  And we’ve seen record numbers of people apply to start new businesses — more than 10 million of them — more than 10 million applications over the last two years starting businesses.

Now we need to keep the program — this progress going.  That’s what swift action that my administration, over the past few years, is all about: protecting depositors, protecting the banking system, protecting the economic gains we have made together for the American people.”

In the U.S./Europe/Japan, as interest rates were traditionally low, NIM/NII were also on the lower side, negative for higher regulatory capital/sufficient buffer requirement to avert such banking crisis from small regional/community banks. Now banking is a deep-pocket business requiring huge buffer capital and may not be suitable for small players. Thus banking consolidation is the only way and along with that governments may also start their public sector banks with a management controlling stake. These PSU Banks may serve the requirements of small community banks as well as large banks by serving both MSMEs and large corporates.

This will ensure also fair competition and balance between private and public sector banks like in India, where the banking system is now very strong after a series of consolidations. Now there are various public as well as private banks, that have physical presence all over the country to serve every section of society. For a big country like India, having a 1.40B population and 80% of them are in BPL (below poverty line) category, financial and digital inclusion is now almost complete. India now has two big PSUs and four big private banks along with some other small private/PSU and cooperative banks. As the banking sector is strategic for any country including India, the government may never convert these PSU banks into private anymore, but will try to improve service and efficiency further; naturally private banks will also follow and improve themselves.

Conclusion:

After SVB/regional banks' fiasco, the market is now expecting a +25 bps rate hike on 22nd March and a pause. Further, some market participants are now also expecting Fed may prefer financial stability over price stability and may not even go for any hike on 22nd March. A few market participants are also expecting rate cuts to the tune of -75 bps by Dec’23 for the sake of financial (Wall Street) stability. Thus Wall Street Futures and Gold jumped, while USD slumped Monday. All focus will be now on Tuesday’s core inflation data, which is expected to come around +5.5% vs +5.6% prior annually (y/y) and +0.4% vs +0.4% prior sequentially (m/m). Any meaningful deviation from expectations will also move the risk assets (negatively for hotter than expected and vice-versa.

Looking at the core CPI trend, it eased from +6.6% in Sep’22 to +5.6% in Jan’23; i.e. 1% decline in 4 months. At this run rate, core inflation may fall to around +4.6% by May-June’23. Thus Fed may hike by another +25 bps on 22nd March and 3rd May for a terminal rate of +5.25% if core CPI comes around +5.3% or low in Feb’23; otherwise, it comes around +5.5% or even +5.7%, then Fed may go for another hike of +25 bps on 14th June for a terminal rate +5.50% and pause thereby till at least Dec’23 to bring down core CPI towards +4.00% ensuring stable economy and employment.

Apart from regional banks, Fed is itself now bankrupt, at least theoretically with a negative net worth currently around -$1.1T. As a debt manager of the U.S. government, Fed along with Treasury has to ensure lower borrowing costs, whatever may be the narrative and thus US10Y bond yield of around 4.25-4.50% is a red line for Fed.

U.S. is now paying almost 10% of tax revenue as interest on public debt and CBO projected around 13% and 15% for 2023-24 even after assuming an average 10Y US bond yield of around 3.80-3.90%. This is a red flag for U.S. fiscal math. China and the EU’s debt interest/tax revenue is currently around 5.5%, while Japan’s is 15%.

As a debt manager of the government, every central bank including Fed has to ensure lower borrowing costs for deficit spending, whatever may be the narrative. Thus Fed will take a balanced approach to control inflation, employment, and bond yields. Fed may not allow a US10Y bond yield above 4.25-4.50% under any circumstances (recent high around +4.08%) whatever may be the narrative.

Fed also has to ensure a softish landing, if not soft (mild employment/economic recession and 2% price stability); i.e. financial and price stability at any cost, If Fed does not hike on 22nd March for SVB/small banks crisis, it may affect its credibility and show Fed is panicking. The U.S. now needs structural banking reform along with proper regulation such as maximum limit for HTM portfolio (in line with Indian/RBI regulation) to avert a repeat of Lehman moment (2008 GFC).

On Monday, Wall Street was boosted by real estate, utilities, tech (lower bond yield), healthcare, consumer staples, consumer discretionary, and communication services, while dragged by banks & financials (regulatory concern and lower bond yields-negative for lending business model), energy (lower oil), materials and industrials