The bankruptcy of Silicon Valley Bank or the effects of the Fed rate increase

The sentiment of the financial markets changed radically from one day to the next, the bankruptcy of a regional bank in the United States sowed fear among investors, the confidence of financial institutions was once again put into question. Last Thursday, March 9, at the close of market hours, the news spread that Silicon Valley Bank (SVB) was in liquidity problems to face the withdrawals of money from its clients, only a few hours of the following day were enough to consummate his imminent downfall.

As expected, the financial markets reacted significantly to an event that was perhaps not so surprising, since much had been said about the effects of the sharp increase in interest rates by the FED in the last 12 months. . The fall of SVB is attributed to the losses that this institution had in medium and long-term bonds, which have lost value due to the increase in interest rates (this does not exempt the directors of this bank from mismanaging risk).

The current economic and financial environment is essential to understand this event and its possible effects in the short and medium term. A year ago, the FED began a period of restrictive monetary policy with the main intention of stopping the inflationary effects caused by the economic stimuli that were given by the Covid-19 pandemic and by the reopening of the economy after the isolation period. Inflation surprised with maximum levels not seen in the last 3 decades, this caused the FED to increase the magnitude of the rate hike, the idea was to cool the economy to stop the escalation of prices. The bankruptcy of SVB is a consequence of these measures. For its part, the market had positioned itself to price in an economic recession, which could be strong or moderate.

The SVB event was not a surprise, it is not that market analysts would have predicted it, but it was not unlikely that the economic and financial agents of the United States could get into trouble as credit became more expensive, since it must be taken into account that the The FED rate came to be very close to 0% for almost two years and until a few days ago it was predicted that it could reach 6.00% in the first half of this year.

The news has continued to spread and Signature Bank is the second bank with similar problems. For their part, over the weekend the government and financial authorities announced that SVB customer deposits are guaranteed, this measure seeks to generate confidence among savers. The main concern is that there is a contagion between financial institutions which would jeopardize the real economy.

A medium-term consequence is that banks will reduce their risk, granting fewer loans, this will generate a decrease in economic activity and therefore inflation is expected to drop. It seems that this event helps the Fed to fulfill its mandate to stop the increase in prices, there are also those who say that this is the beginning of the recession. It will be necessary to closely monitor the other effects that may occur due to the aggressive increase in rates. What can be sure is that the market will continue to show some volatility over the next few days.

The author is VP Portfolio Manager Senior Debt – BBVA Asset Management.

juanernesto.gonzalez@bbva.com