BentinPartner Weekly
Last week main event was supposed to be Fed Chair Powell congressional testimony on Monday and Tuesday, followed by Friday’s job report and to some extent it was… until Thursday’s bombshell that drove the Banking index into a 7% selloff.
The main message from the Fed, early last week, was that the peak policy rate could be higher than originally thought and that the Fed could accelerate the pace of monetary tightening (read deliver a 50bps rate hike later this month instead of 25bps), on the premise that core inflationary pressures remain too high and the labour market too tight.
Then the news hit that crypto bank Signature (SI) was liquidating, triggering along with some rising tumult at Silicon Valley Bank (SVB), a 7% loss in the US banking index.
On Friday, the US employment report was supposed to carry the news of the day and delivered an upside surprise (+311k NFP vs. 225k expected and), suggesting the labour market was stronger than the Fed anticipated a few weeks ago, although some cracks appeared in the report as well, with a miss on average hourly earnings (+0.2% vs. +0.3% expected) and an increase in the unemployment rate (to 3.6% from 3.4% previously and expected).
This initially left the market switching attention on this Tuesday’s CPI report (Mom expected at +0.4% and Year over Year expected at 6.0%) to forge a final opinion about the next Fed move (25 bps or 50bps…) until the news broke out that SVB witnessed a flash “run on the bank” after an unsuccessful attempt to raise capital to cover a USD1.8bn loss on its bond portfolio. Later in the day, news that the bank was put under control of the US Federal Deposit Insurance corporation (with employees offered 45 days of employment) sent the shivers down the spine of markets, causing a super strong rally in bonds (the long bond recouped 4.5%) and a mirror like decline in global equity markets.
What happened was this…
With the exception of last year (when the tech bubble started to deflate), SVB balance sheet grew very fast with deposits from start-ups doing the same.
Rather than using this source of funds to make (smart or stupid) loans, SVB seems to have bought “zero weighed” 10-year US treasuries, undertaking most of their 9-year duration risk (interest rate sensitivity implying a 9% loss for every 1% move in yield) on most of its balance sheet... When bond yields rose (last year and this year until Friday), the bank’s bond portfolio was inflicted significant losses that were left unaccounted for because the bonds were categorized as “Held to Maturity” i.e. relieved from “mark to market” obligations because the “intention” was to keep the securities till maturity.
Such was the original intention except that with the depositors base shrinking (from a slowing VC business), the bank’s deposit base shrank rapidly forcing SVB to …sell bonds that were “intended” to be held till maturity, materializing large losses which propelled the bank from a liquidity crisis to a solvency crisis and ultimate to its flash demise on Friday.
This outcome could probably have been avoided by taking out part or all of the bonds’ duration risk with interest rates swaps. But the temptation was likely too strong to sit on a larger carry (when the curve was not inverted…and the term premium positive) with no theoretical ‘market risk’ and the belief that yields would never rise again…
This is where 20 years of ZIRP (zero interest rate policy) led to… with brilliant young minds at the helm of banks’ risk management departments not being aware of basic bond math…most likely because they have never seen bond markets going down, did not understand liquidity risk nor how painful it can be when yields creep decisively higher.
With all due respect and as J. Gundlach said in a CNBC interview overnight, the net worth of the Fed is now -1.1trillion (just like the Bundesbank, it seems) due to essentially the same funding/investing mismatch that took down SVB, suggesting that the only way for the Fed to backstop the system is to print money…
"If it had been Lehman Sisters rather than Lehman Brothers in 2008, the world might well look a lot different today", Christine Lagarde once famously said.
It seems she may have been proved wrong , enabling SVB so settle scores on gender inclusiveness as well when it comes to failed risk management (Fatal Distraction, ZH).
The reaction we saw Friday was a partially atypical “risk off” flush in that it pressed equity markets and EM currencies (after their recent strong performance) but it did not support the dollar in aggregate which actually dropped on Friday.
The disconnect between the dollar going up and risk off session is not a new phenomenon as witnessed by the now rapidly declining correlation between the dollar index and the Vix index (a generally accepted measure of risk).
Fig.1: Correlation between “risk” and the dollar
Click on the Picture below for our latest Leaders & Laggards Report:
Over the past week, the S&P500 sold off by -4,5% (0,9% YTD, Z-score -2,1) while the Nasdaq100 sold off by -3,7% (8,4% YTD). The US small cap index sold off by -8,0% (1,0% YTD, Z-score -3,1). AAPL dropped -1,7% (14,3%).
The Banking Sector shed 14.7% on the week (essentially in 2 days). Metals and Mining shed -11% while Materials dropped -7.6%.
Cboe Volatility Index rallied 34,1% (14,4% YTD, Z-score 2,6) to 24,8.
The Eurostoxx50 dropped -1,5% (11,9%), outperforming the S&P500 by 3%.
Diversified EM equities (VWO) sold off by -3,9% (0,4%), underperforming the S&P500 by0,7%.
The Dollar DXY Index (UUP) measuring the USD performance vs. other G7 currencies gained 0,1% (1,9%) while the MSCI EM currency index (measuring the performance of EM currencies vs. the USD) dropped -0,5% (0,4%).
10Y US Treasuries rallied -25bps (-18bps) to 3,70%. 10Y Bunds dropped -21bps (-6bps) to 2,51%. 10Y Italian BTPs rallied -21bps (-40bps) to 4,32%, matching Bunds.
US High Yield (HY) Average Spread over Treasuries climbed 53bps (-19bps, Z-score 2,4) to 4,50%. US Investment Grade Average OAS climbed 17bps (8bps, Z-score 3,3) to 1,51%.
In European credit markets, EUR 5Y Senior Financial Spread climbed 6bps (-7bps, Z-score 2,1) to 0,92%.
Gold gained 0,6% (2,4%, Z-score 2,2) while Silver sold off by -3,4% (-14,3%). Major Gold Mines (GDX) sold off by -5,0% (-5,1%).
Goldman Sachs Commodity Index sold off by -3,4% (-5,8%). WTI Crude sold off by -3,8% (-4,5%).
Overnight in Asia,,,
Ø S&P500 +50 points; Nikkei -1.6%; CSI300 +0.5%
Ø With most of the deposits not covered the FDIC and SIPC in an effort to mitigate rapid contagion risks, and no bank advancing to take back CVB deposit base, the Fed announced overnight in a communiqué that it would “bail out” all depositors of SVB (and of Signature Bank) with a USD25bn dedicated Fund (new acronym called BTFB).
Ø The overnight response was for stocks to recover Friday’s losses, bonds to sell off moderately, the dollar to drop further and gold (and surprisingly bitcoin as well) to rally.
Ø The market is now assuming the Fed will only tighten by 25bps this month with chances it will have to pivot later his year increasing solidly as well….and as we speak, more like we get no more rate hike according to Goldman Sachs.
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Marc Bentin serves as Economic Advisor to Blue Lotus Management,
a specialist multi-manager investment firm, which seeks to provide investors a compelling alternative to the traditional 60/40 equity and bond portfolio by targeting higher returns without amplifying equity risks.
BentinPartner GmbH is Advisor to the Phi Funds AIF, an umbrella Alternative Investment Fund registered and regulated in Lichtenstein, specializing in the management of Funds focused on physical precious metals.
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