Two weeks ago the main focus of market participants was whether inflation would stay elevated and how Fed policy may impact economic growth. There was almost no talk about how high interest rates had impacted the financial sector.
Banks like Silicon Valley Bank (SIVB) and Credit Suisse (CS) have had some clear problems, but it wasn't an issue that was impacting the stock market to any great degree until a sudden run on deposits at Silicon Valley Bank showed how precarious the liquidity situation was.
At first, the market attempted to shrug off SIVB as a one-off situation. It catered primarily to venture capital and start-up firms and had an unusually high level of deposits that exceeded the FDIC insurance coverage of $250,000. However, the situation turned out not to be that unique. There are hundreds of other, mostly smaller and regional banks that are sitting on huge unrealized losses and are vulnerable to a lack of liquidity should there be a sudden rush to withdraw funds.
Fed officials in the US moved very quickly to deal with the issue. They backstopped SIVB and Signature Bank (SBNY) , so depositors were protected and created a program that allowed banks to borrow against bonds with unrealized losses at face value.
The crisis quickly spread overseas and hit Credit Suisse last week. Swiss authorities engineered a forced take-over of the troubled bank by UBS (UBS) .
Market players are relieved that swift action has been taken, but the problem now is that the market has to recognize the huge cost of this rescue. CS's stock has been cut in half, and UBS has been down over 10% since Friday. Banks in the US are still trying to stabilize as they digest the news.
The bigger and more general question now is how this will impact interest rates, economic growth, inflation, and Fed policy. While banks struggle to find support, the market will grapple with all those issues as we head into the Federal Open Market Committee interest rate decision on Wednesday.
Because of the bank crisis, the Fed is forced to be less hawkish than it was two weeks ago. Two weeks ago, there was an 80% chance of a 0.5% interest rate hike this week. Currently, there is a 40% chance of no hike at all.
Not only is the Fed forced to be less aggressive with interest rates, but it is being forced to undo a large amount of quantitative tightening in order to finance banks that need liquidity for bonds with unrealized losses. On Sunday night, central banks worldwide announced a correlated program to provide daily liquidity to banks.
What we don't know is if a less hawkish Fed will cause a rebound in inflation or if this banking crisis will trigger the economic recession that many strategists have been predicting. Several strategists have stated that they believe that the next down leg in the bear market has started and will be driven by slower economic growth caused in part by tighter lending standards at troubled banks.
The situation is confused further by rotation into some big cap technology, semiconductor names, and bitcoin. Precious metals have also benefited, while commodities like oil have been hit hard.
Technical conditions are generally poor, but there is enough liquidity to prevent any real panic from building.
My game plan is to do very little while the market tries to sort out the issues that are hitting. I see no reason to rush to put capital to work and am quite confident that there will be plenty of opportunities in the months ahead to build longer-term positions.
This is the market for capital preservation more than anything else right now. We still have a very long way to go before the banking crisis is resolved, and the Fed is in an extremely difficult situation as it still must contend with inflation while dealing with the problems in the financial sector.
Unless you have an extremely short-term time frame, this is a good time to stand aside.