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Silicon Valley Bank’s Shockwave of Uncertainty Likely to Settle
The surprise failure of Silicon Valley Bank and acquisition of Credit Suisse have sent shockwaves of uncertainty across financial markets. Chief Investment Strategist for North America Chris Shipley explains how it’s impacting investors.
The surprise failure of Silicon Valley Bank and acquisition of Credit Suisse have sent shock waves of uncertainty across financial markets. Rarely seen volatility in treasurys, including a dramatic drop in rates across the yield curve highlight investors' flight to safety as they contemplate other potential shoes to drop. While short-term volatility will likely continue, we believe markets will find their footing. Let's take a closer look.
We expect global markets will cycle through a list of potential worries, keeping volatility high in the near term. While bank stocks have dropped, global equities have held up surprisingly well, with US stocks benefiting from a move to growth stocks as interest rates have declined.
Futures training now shows expectations of the Federal Reserve cutting rates three-quarters of a percent this year, versus expectations of further hikes just two weeks ago. The Fed now must walk a tightrope of reinstating price stability while maintaining financial stability. Tighter financial conditions and some likely pullback in consumer and business activity should soften the inflation outlook somewhat, but we do not expect the Fed to be cutting rates this year in the base case.
Importantly, we see dramatic differences between today's environment and the 2008 global financial crisis. In aggregate, far more capital and liquidity combined with much better oversight have significantly reduced systemic risk. While Silicon Valley Bank's failure has exposed underappreciated vulnerabilities, their issues were hidden in plain sight.
In 2008, poor lending standards and off-balance sheet or complex financial structures magnified and obfuscated risks. Investors, regulators, and sometimes the companies themselves gravely misread those risks. We believe intervention from regulators last week to provide liquidity to banks will do much to provide stability to the banking system. Still, investors will likely require the passage of time as proof.
The impact of the current concerns on economic growth and inflation likely depends on how long the uncertainty lasts. The longer it takes, the larger the potential drag on the economy as businesses and consumers likely slow their spending as they wait out the storm. Our base case is that investors will gain confidence that the fallout will be contained.
In our global policy model that guides our multi-asset portfolios, we remain neutral to risk, acknowledging the risk of a slow return to stability, but also the likelihood of current conditions giving way to still reasonable growth and slowing but stubborn inflation. We are underweight investment grade bonds and overweight high yield. We think markets have priced in too negative an outcome in the fixed income markets.
Developed market equities appear to fairly price the balance of risks, so we remain neutral. We are underweight emerging markets given continued uncertainty in China, with an offsetting overweight to natural resources amid persistent inflation.
