Stocks: Why the Silicon Valley Bank bust is good

The collapses of Silicon Valley Bank, Silvergate Capital and Signature Bank in recent days made scary headlines. For equity investors, however, they could have positive effects.

The US Federal Reserve could be forced to slow the pace of its rate hikes. This would be welcome news for investors battered by tightening financial conditions, as evidenced by stock markets’ weak start to the year.

It would also help ease the pressures that led to the collapse of these financial institutions. After all, it was the rising interest rate environment that put companies in this precarious position in the first place, with risk-free government bonds yielding higher yields than their own. Customers withdrew their money and fled to safer investments, and the panic eventually led to a run on the banks.

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Now that the prospect of further rate hikes has faded, investors are trying to reassess the impact on the two main drivers of stock gains: corporate earnings growth and risk appetite. Market action on Monday was positive, with all three US indices gaining, with the rate-sensitive Nasdaq leading the rise, up 1.4 percent.

Wall Street is optimistic

A number of Wall Street firms, most notably Goldman Sachs, have already forecast a pause in rate hikes. “With the recent tensions in the banking system, we no longer expect the Fed to hike rates at its March 22 meeting, and there is significant uncertainty about what happens next,” Goldman Sachs chief economist Jan Hatzius wrote in one notice to its customers.

This is important news. Stocks fell just last week after Fed Chair Jerome Powell took a dovish stance before Congress. This had led the market to expect a 50 basis point rate hike next week, followed by at least a few more later in the year.

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Some are now recognizing the vulnerability of the US regional banking sector. Market expectations are leaning toward the previously unthinkable: rate cuts later this year. That would give the stock markets a powerful boost.

Key market dynamics are changing

Rapidly rising interest rates in 2022 weighed on company valuations and sent the stock market into a doldrums. Now the exact opposite dynamic is at play. The US 2-year Treasury yield fell more than 40 basis points on Monday and is down almost 90 basis points since the end of last week.

Compared to risk-free bonds, which have lost their attractiveness, equities suddenly appear more attractive again. As long as the Fed does not continue raising rates, the uptrend could be broken for good, making lower rates possible.

“Given the turmoil in financial markets over the weekend and signs of a sudden surge in risk aversion, we now believe that a 50 basis point rate hike is off the table next week and that the decision will be between a 25 basis point rate hike or a pause ‘” Barclay’s said in a statement Monday. “While we cannot rule out the first scenario, we believe the most likely outcome will be a hiatus.”

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It wouldn’t be the first time in history that the Fed has done this

There is historical precedent for what investors are predicting. Some have pointed to the 1994 Orange County bankruptcy as an event that parallels the current interest rate environment. In 1994, the Fed aggressively hiked interest rates to slow the economy, raising interest rates from about 3 percent to 6 percent. This large increase contributed to Orange County’s bankruptcy. The Fed’s next decisions were a rate pause and eventually a rate cut in the summer of 1995.

The stock market performed remarkably well in the years that followed. If the Fed shares the same fears that it has broken something and decides to be cautious about further rate hikes, the stock market could show a similar bullish reaction.

This article has been translated from English. You can find the original here.