The collapse of Silicon Valley Bank (SVB) has sent shockwaves through the banking industry, serving as a stark reminder of the vulnerability of the sector to the Federal Reserve's policies.
Just a year after the Fed began aggressively raising interest rates, the collapse of Silicon Valley provided Wall Street with the answer to its most pressing question: "When is something going to break?" This marked the largest bank failure since the 2008 financial crisis, forcing managers to reassess the Fed's preparedness to continue tightening policy to combat inflation. Investors are betting that the Fed will only raise rates one more time, if at all, this year, with officials being forced to start cutting rates before the end of the year.
Ironically, the economy is holding up well, companies are still hiring, and default rates remain low, so the acute pain from rising rates has yet to materialize. Currently, the Fed is caught between stubbornly high inflation and signs of stress in the banking industry.
"Now we're starting to see the monetary policy work, albeit belatedly," said Blerina Uruci, chief economist at T. Rowe Price Associates, in an interview with Bloomberg Television on Friday. "The first signs of that are what we're seeing with Silicon Valley. There are likely many businesses and banks that cannot operate at rates higher than this."
The expected 400 bps rate increase by the Fed was expected to brake the labor market, but this has yet to occur. "A year ago, if the Fed had tightened 450 bps in 12 months, you would have thought the economy would go into a recession, but the reality is that it hasn't had much impact."
Although SVB's difficulties are unlikely to pose a systemic financial risk, its stunning collapse is a reminder that the banking industry remains vulnerable to rapidly rising interest rates after years of operating in a low-interest-rate environment. Its failure forced the Fed to establish a new emergency facility that allows banks to pledge a range of high-quality assets for cash loans with a one-year term. And regulators have also pledged to protect even uninsured depositors.
The collapse of SVB shows that monetary policy is starting to have an impact, the question now is how the Fed will balance the task of restraining inflation with the cracks in the economy...