Bank Contagion Fears Spread to Global Markets: Time to Buy Short-Term Treasuries?
Frank Holmes | Mar 16, 2023 01:52PM ET
Bank contagion has officially spread to international markets, raising fears that last week’s dramatic failures of U.S. lenders Silicon Valley Bank (SVB) and Signature Bank may be just the start of another global crisis.
Shares of Credit Suisse (NYSE:CS), one of Europe’s top 20 largest banks by assets, plunged more than 32% in intraday trading, hitting a new all-time low following reports that the Swiss bank continues to see depositor outflows.Yields on short-dated U.S. Treasury bonds fell to their lowest levels in months on increased safe-haven demand. (Bond yields and prices move in opposite directions.) The 6-month yield traded as low as 4.5% on Wednesday, while the 1-year yield came close to breaking below 4.0% for the first time since October 2022.
I believe the longer the bond rally continues, the longer fears of a full-blown banking crisis will persist. Investors interested in capital preservation right now can do much worse than short-term Treasuries, which are less volatile than longer-dated bonds.
h2 Long-Term Debt Contributing to Massive Unrealized Bank Losses/h2In fact, long-term Treasuries are a big part of the reason why banks are under pressure at the moment.
Why? I’ll let equity research strategist Lyn Alden explain because I don’t believe I would be able to do a better job than she does:
"Banks were given a ton of new deposits during 2020 and 2021 thanks to fiscal stimulus to people, and banks used those deposits to buy a lot of [Treasury] securities, which were low-yielding at the time. After a year of rapid interest rate increases, the prices of those fixed-income securities are now lower than they were when banks bought them."
Remember, yields and prices go in opposite directions. What this means is that U.S. banks now have massive amounts of unrealized losses on their books—an estimated $620 billion, all told. To clarify, these are assets that have decreased in value due to rising interest rates but haven’t been sold yet.
As Alden points out, banks should be fine if they hold these securities to maturity and get their principal back. But not every bank is able to do that.
The problem is that if there’s a run on a bank and depositors seek to withdraw more cash than the institution has on hand, it may be forced to sell its highly discounted bonds, thereby locking in those losses.
Get The News You Want
This is precisely what happened to SVB. To fund redemptions, the bank reportedly had to sell its $21 billion bond portfolio… for a loss of $1.8 billion.
h2 Where Has All the Liquidity Gone?/h2Making matters worse is that liquidity is drying up, and fast. M2 money supply is how the Federal Reserve defines cash as well as everything that’s deposited in checking and savings accounts. Again, in the first couple of years of the pandemic, the supply of M2 money skyrocketed. This helps explain why inflation is where it’s at today, and to combat higher prices, the Fed has had to significantly tighten monetary policy.
You can see the results below. For the first time in decades, M2 money supply has actually gone negative.
Taking into consideration the risk of systemic bank failures, among other risks, the Fed may be more likely to pause or even reverse quantitative tightening.
This possibility is reflected in the market’s current pricing, as seen in the CME Group’s FedWatch Tool, which uses fed funds futures pricing data. As of Wednesday, the implied probability of interest rates being between 3.75% and 4.00% by January 2024 was 29%, compared to the current rate of around 4.58%. However, this is just a probability and may not be accurate.
However, if you believe that the Fed is more likely to lower rather than raise rates this year, then buying short-term bonds may be a good option. When rates are expected to fall, investors often turn to short-turn debt as a way to lock in current yields before they decline.
This is the opposite strategy of banks like SVB.
***
Disclaimer: Investing involves risk including the possible loss of principal. Bond funds are subject to interest-rate risk; their value declines as interest rates rise. Past performance is no guarantee of future results.
An available-for-sale (AFS) security is a debt or equity security purchased with the intent of selling before it reaches maturity or holding it for a long period should it not have a maturity date. A held-to-maturity (HTM) security is purchased to be owned until maturity. M2 is the U.S. Federal Reserve's estimate of the total money supply including all of the cash people have on hand plus all of the money deposited in checking accounts, savings accounts, and other short-term saving vehicles such as certificates of deposit (CDs).
All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor.
Trading in financial instruments and/or cryptocurrencies involves high risks including the risk of losing some, or all, of your investment amount, and may not be suitable for all investors. Prices of cryptocurrencies are extremely volatile and may be affected by external factors such as financial, regulatory or political events. Trading on margin increases the financial risks.
Before deciding to trade in financial instrument or cryptocurrencies you should be fully informed of the risks and costs associated with trading the financial markets, carefully consider your investment objectives, level of experience, and risk appetite, and seek professional advice where needed.
Fusion Media would like to remind you that the data contained in this website is not necessarily real-time nor accurate. The data and prices on the website are not necessarily provided by any market or exchange, but may be provided by market makers, and so prices may not be accurate and may differ from the actual price at any given market, meaning prices are indicative and not appropriate for trading purposes. Fusion Media and any provider of the data contained in this website will not accept liability for any loss or damage as a result of your trading, or your reliance on the information contained within this website.
It is prohibited to use, store, reproduce, display, modify, transmit or distribute the data contained in this website without the explicit prior written permission of Fusion Media and/or the data provider. All intellectual property rights are reserved by the providers and/or the exchange providing the data contained in this website.
Fusion Media may be compensated by the advertisers that appear on the website, based on your interaction with the advertisements or advertisers.