The collapse of two US banks raises the stakes for the Fed (2024)

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The collapse of two US banks raises the stakes for the Fed (1)The collapse of two US banks raises the stakes for the Fed (2)The collapse of two US banks raises the stakes for the Fed (3)The collapse of two US banks raises the stakes for the Fed (4)

Two regional US banks, California-based Silicon Valley Bank (SVB) and New York’s Signature Bank, have collapsed under the weight of heavy losses on their bond portfolios and a massive run on deposits. They are the largest banks to fail in the US since Washington Mutual in 2008 (Washington Mutual had about US$309bn in assets at the time of its collapse, compared with SVB’s US$209bn).

Why does it matter?

For now, we do not expect the collapse of SVB and Signature to spread to the broader banking sector. For one, regulators moved swiftly to shore up market confidence and prevent more bank runs by providing additional liquidity in exchange for eligible assets. In an unusual move, the Federal Reserve (Fed, the central bank), the Federal Deposit Insurance Corporation and the Treasury Department committed to ensuring that all depositors in the two banks would regain access to their funds (which was restored on March 13th), even those not covered by the government’s deposit insurance scheme. Any losses suffered by the deposit insurance fund will be recovered through a special levy on other banks, rather than through taxpayer funds.

Although rising interest rates will weigh on the financial sector broadly, the two banks’ collapse was partially due to their unique positions. SVB was heavily exposed to risky technology start-ups and had an unusually large portfolio of bonds, making it vulnerable to the sharp rise in interest rates. Similarly, Signature had connections with the cryptocurrency sector, which has been roiled by uncertainty since the failure of the FTX exchange last November. Furthermore, the vast majority of deposits at both banks were above the US$250,000 limit for federal deposit insurance, making them susceptible to withdrawal at the first hint of trouble. Nevertheless, higher interest rates will be a continuing source of financial risk in 2023‑24.

Last week Fed officials were considering a larger, 50-basis-point rate rise at their March meeting. The banks’ collapse and a subsequent sell-off in regional bank shares have eliminated this risk. There is now a chance that the Fed could choose not to raise interest rates at all in March. We expect the Fed to maintain its more modest pace, with a 25-basis-point increase, in response to still-strong economic data in January and February.

What next?

We continue to expect the Fed to make three more 25-basis-point rate increases, bringing its policy rate to a peak range of 5.25-5.5% in June. However, risks have quickly moved to the downside since last week. If investor sentiment weakens further, or if more regional banks start to struggle, which we do not expect, the Fed may keep rates on hold in March.

The analysis and forecasts featured in this piece can be found in EIU’sCountry Analysisservice. This integrated solution provides unmatched global insights covering the political and economic outlook for nearly 200 countries, enabling organisations identify prospective opportunities and potential risks.

Article tagsEconomyFinancial ServicesAmericasCountry Analysis

The collapse of two US banks raises the stakes for the Fed (2024)
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