Market Focus Moves from the Fed to Financial Crisis

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Yesterday, the Fed completed its regular meeting and announced that it would increase interest rates by 25 bps, or a quarter percentage point. This move was in line with expectations, and markets shrugged. Even at the press conference, when some awkward questions were asked (which Chair Powell ducked), markets bounced around but remained calm. But then something else happened. After Powell had gone to some trouble to assure people that their deposits were safe (without actually committing to anything), Treasury Secretary Janet Yellen was asked whether there were plans to dial up deposit insurance across the board. She said no, and then the market started to sell off.

No Longer About the Fed

So, what can we take away from what happened yesterday? My own take is that this is no longer really about the Fed. It raised rates but signaled there would be one more hike and no more. Markets were fine with that because they expect a recession and consequent rate cuts by the end of the year. Although Powell was quite clear that inflation remains the priority, his comments in the press conference started out with a recognition of the risks from the current bank turmoil. The Fed is no longer what markets are worried about and neither, really, is a recession. What markets are now worried about is a financial crisis.

This shift is interesting because what we are seeing is that while there are problems—First Republic comes to mind immediately—overall the system is still working as it should. The FDIC continues to work on resolving Silicon Valley Bank (SVB). Rescue operations from the private sector are underway at First Republic. FDIC examiners are all over other banks at risk. There may be more bank failures, but they will be normal ones, under FDIC observation and control. Unless, of course, something else happens. What could that be?

We have some hints. While the last crisis was all about bad assets and lack of transparency there, this crisis is about bad liabilities: deposits. SVB had a big asset problem. What pulled the plug was the technology-mediated sudden flight of deposits. Credit Suisse had the same problem, along with a bunch of others. The market’s reaction to Yellen’s comment yesterday supports that idea. If deposit insurance is the problem, it is because the lack thereof can cause deposit flight from many banks. QED.

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