Banking on additional uncertainty
By Kyle Tetting
While the postmortem on Silicon Valley Bank’s collapse is still being written, there’s plenty of blame to go around. From bank executives and their advisors to the bank’s largest clients, to the Federal Reserve itself. There may be bits of blame for each, but the harsh reality is that such a high-profile bank failure has resulted in many questions about who or what is next.
A problem that had little to do with regional banks in the Midwest or other parts of the country suddenly weighed on the whole system, causing customers elsewhere to wonder about their banks. Fortunately, the 2008 financial crisis provided lessons in the importance of stabilizing the confidence of bank customers. As a result, the government moved deliberately to reassure Silicon Valley Bank customers that they would be made whole — not strictly for their benefit but to stabilize the system.
Such interventions come at a cost. For example, banks likely will face increased scrutiny in certain areas and increased costs to participate in deposit insurance with the FDIC. Those costs would be passed on to bank customers through fees or worse banking terms — or to shareholders through lower profits.
Beyond hard costs, there’s also renewed distrust in the financial system. Such unease adds to broad market volatility. In the early days of the current banking crisis, measures of implied market volatility showed a spike in investors’ expectations of risk. Further, the availability of credit has tightened as banks increase scrutiny on their lending.
Amid all the commotion in the banking system, the Federal Reserve was set to meet on monetary policy. Its eventual announcement on March 22 raised the overnight rate a quarter point — less than expected based on earlier comments from the Fed. But, included with the rate announcement were affirmations from Fed Chair Jerome Powell that the banking system is sound and that the Fed is watching closely.
None of these actions or events exist in a vacuum. The Fed’s response to inflation is shaped by broader economic expectations, which are further shaped by the confidence, or lack thereof, in the banking system. Add in that the impact of each of these developments takes weeks or months to manifest, and it’s clear the Fed continues to aim at a moving target.
For investors, the result is a stock market rife with uncertainty, though such uncertainty for stocks isn’t entirely noteworthy. But what’s more important is that bonds now offer a higher degree of certainty than we’ve expected for years.
With the banking system weighing on the broader economic forecast, the path for interest rate hikes is less clear. Even as Fed leaders remain committed in their projections, investors appear less convinced that rates will keep rising or even stay as high as they are for much longer. According to the CME Fed Watch tool, there is now a meaningful probability that by fall, rates already will be moving lower.
Two things remain clear in all of this.
- First, the immediate future for stocks is as cloudy as ever. However, there are a multitude of reasons to be excited about stocks beyond the immediacy of the current crisis. The monetization of artificial intelligence, the continued emphasis on more regional manufacturing, and evolutions in technology all present opportunities for investors thinking beyond now. As a result, stocks remain the best tool for long-term investing, even if tomorrow isn’t as certain.
- Second, the immediate future for bonds looks far more promising. The very uncertainties that challenge our outlook for stocks are shaping up to turn a 2022 of stiff head winds into a 2023 of light breezes for our bond funds. A path in which rates finally stabilize or even take a step back allows bond funds to provide a higher interest rate with less pressure on the prices of the underlying bonds.
We must address the obvious concerns raised by continued economic uncertainty. But the correct course is not to assume the worst and jettison stocks entirely. Instead, we should embrace the opportunity the uncertainty provides while ensuring we have appropriate allocations to the piece that should finally provide us with a little more confidence going forward.
2023 outlooks not bound by the calendar by Kyle Tetting
The Fed: What investors should know, a Money Talk Video with Dave Sandstrom
Investor upsides as interest rates rise, a Money Talk Video with Kendall Bauer
Stocks: Long-term, consistent returns, a Money Talk Video with Dave Sandstrom
Be patient holding bonds as rates rise, a Money Talk Video with Steve Giles
(initially posted March 31, 2023)