The rescue of SVB takes centre stage with CPI waiting in the wings

There is only one story for financial markets right now, and that is what will happen to Silicon Valley Bank? At the time of writing, regulators, who took control of the bank on Friday 10th March, were holding an auction of the bank on Sunday afternoon. The hope is that a buyer will be found before markets open on Monday. We think that a large systemically important bank, is likely to be the preferred purchaser, as they could offer deposit protection and help some of these start-ups eventually make it to IPO. If this does happen, then we could see markets rally on the back of a financial crisis averted, however, if this doesn’t happen then expect volatility to surge and risk sentiment to drain from the market.

Selling SVB – no mean feat

Hopes are high that US regulators can find a buyer, after reports late on Sunday that HSBC was a potential “white knight” bidder for the UK arm of Silicon Valley bank. HSBC is likely to be the biggest bank bidding for the firm, with a slew of smaller banks said to make an offer. The question now is, how quickly can a buyer move on a transaction? No doubt they will still want to do a thorough due diligence on any purchase of SVB, to see what it is they are buying. But will this be enough time to save SVB from administrators, and thousands of start-ups from financial ruin? In a cost-of-living crisis, there will be little public support for bailing out the bank using taxpayers’ money, especially here in the UK. Yet, after the 2008 financial crisis, some larger, more stable players were burnt buying their troubled rivals, think JP Morgan buying Bear Stearns, and Bank of America with Merrill Lynch. Thus, it may be hard to get a knight in shining armour at the eleventh hour. If there are no buyers for SVB, then US authorities have touted the prospect of creating a fund to protect business deposits, however, this is only likely to fuel more risk aversion, as it is hardly a long-term workable solution.

How to trade the unknown

This makes it practically impossible to position for the trading week ahead. If there is a successful sale, then we could see risk appetite rise, yet it could hurt the “white knight’s” share price if there are any areas of concern on SVB’s balance sheet or its business model. If there is no sale, then we could see panic in financial markets. To think, a week ago, the market was focused on the Fed being “data dependent” regarding its next move in interest rates, now the Fed is SVB dependent.

Why SVB was in trouble in the first place

Overall, this is not a solvency crisis like in 2008, and its problems are not down to bad loans or poor investments. Rather, this is an old-fashioned bank run, with too many people wanting to get their money out of the bank all at once. Due to this, SVB could not convert its asset base to cash to fulfil those deposits quick enough, hence the panic in the market. There are still some questions about why companies had requested to take their funds out of SVB in the first place. This didn’t just happen last week, it takes 30 days to retrieve funds, since $42bn was withdrawn on Friday, companies who used the bank had started the process to withdraw funds in mid-February. The answer is two-fold: 1, as Treasuries rose more than bank deposits, savvy investors preferred to put their money in short term government debt, as that is where they will make the biggest return, and secondly, the tech sector has been in trouble for some time, especially in the smaller end, so they may have needed cash to repay investors etc.

How to solve the problem afflicting the financial sector

The answer to this crisis is two-fold, to really calm the markets the root-cause of this crisis needs to be addressed. This requires banks to increase their savings rates for depositors, to stop them from pulling their bank deposits in the first place. For example, in the UK, interest rates are expected to rise to 4.75% later this year, yet the average easy access savings account rate is 3.6%. Lloyds Bank is charging interest of less than 2% for some of its cash ISA products. People are looking for a higher return elsewhere, especially since that return is found in the safest asset in the world: short term US government debt. Thus, until money market rates fall, banks may see people pull deposits. Added to this, the tech sector is struggling, and while some start-ups may be in the position to pull their deposits and search for a higher yield elsewhere, others will have had high cash burn rates over the past year, leading to dwindling deposit rates. This will have exacerbated SVB’s problems. The second fix for this problem, is for deposit insurance for businesses to rise substantially. Some are calling for the FIDC in the US to increase their deposit insurance ceiling to unlimited, like they did in 2008. This is to thwart the prospect of a bank run elsewhere when markets open on Monday.

What will the Fed do next?

Overall, this is one consequence of 450 basis points of US interest rate hikes in less than 12 months. The question now is, how will the Fed react? The payrolls report was solid- above 300k, although the unemployment rate ticked higher, which could give some hope that jobs growth is coming off the boil. However, US CPI data due on Friday, will be interesting. The market is expecting a 0.4% increase in headline prices for Feb, with the annual rate dropping to 6%, core prices are also expected to rise by 0.4%, and the annual rate is expected to drop a notch to 5.5% from 5.6%. If correct, then these are still large monthly increases, which may not give the Fed solace that their interest rate hikes are working. Will stubborn inflation, or the prospect of a collapse in the links between funding and start-ups weigh more heavily on the Fed decision later this month? We think that a weaker than expected reading of inflation will solidify expectations of a 25bp rate hike in 2 weeks, while a stronger CPI reading could trigger a broad-based sell off in risk assets across the globe.

While there is other economic data to watch this week, we will update you on that later this week. For now, all eyes are on SVB and its future.