Weekly Economic Trends and Indicators

The Headline:

On March 10, Silicon Valley Bank (SVB), a key player in the world of start-up financing, failed due to a run on its deposits. The Federal Deposit Insurance Corporation (FDIC) stepped in to facilitate an orderly transition as regulators attempt to find buyers for the bank’s assets. This was the largest bank failure in the US since the 2008 financial crisis. The resulting fallout in the financial markets this week has cast uncertainty on the upcoming Federal Reserve interest rate decision and the likelihood of a recession.

The Details:

The failure of SVB was due in part to the decline in the value of their bond portfolio as a result of rising interest rates. Bond prices and interest rates move in opposite directions. As the Fed raised short-term interest rates so dramatically last year, the value of all those bonds on the asset side of SVB’s balance sheet decreased sharply. However, this drop in the value of their assets is not realized until they began to sell those bonds. It was not until recently, as their depositors began to withdraw funds in larger amounts than usual that SVB began selling the bonds to cover the withdrawals and keep their balance sheet in balance.

The Context:

There are some important takeaways from this episode. First, the swift action by the Fed, the Treasury, and the FDIC to reassure the public that depositors would be made whole, even those whose deposits exceeded the insured limit, contained any panic that may have been building over the weekend of March 11-12 and prevented this from spreading further into the banking world at the beginning of the week. Investors in SVB (owners of stock or bonds in the bank) will not be bailed out, sending a message to investors elsewhere to assess the risks throughout the system.

SVB’s specific circumstances are somewhat unique. Traditional banking institutions such as we find throughout our region are less vulnerable to the risks that troubled SVB. Nevertheless, this episode drives home the fact that the rapid increase in interest rates last year has consequences. This will slow lending activity in the startup sector. The ripple effects are likely to slow demand for hiring in the tech sector, leading to slower demand in adjacent sectors. In short, this is evidence that the rate hikes have done exactly what the Fed was hoping, namely slow down the economy in the hopes of bringing inflation under control.

But was it too much? Earlier in the week, the market started to anticipate that the Fed might pause the rate hikes at this meeting. By week’s end the sentiment had (mostly) returned to the previously expected 25 basis points (1/4 of a percent). Inflation numbers released this week were still uncomfortably high. At their March 22 meeting, the Fed will likely send the message that they will continue to fight hard against inflation, even in the face of financial market stress. They must also continue to reassure market participants that they will not allow this stress to break the system. This delicate balancing act just becomes significantly more difficult.

Next week: Local labor market update