Quite an exciting week and a half and I have some additional commentary to share in addition to this week’s MMG update (below). Silicon Valley Bank failed for several reasons, and while it is of course the bank’s responsibility to manage risk, it was the Fed being late to the game in hiking the Fed Funds rate and then hiking so much in such a short period of time that pushed SVB’s bond holdings so significantly underwater. SVB held a large position in government bonds, which are generally considered the world’s safest parking for money, and those bond yields were as close to zero as they’ve ever been. A bond’s value on the market can be determine primarily by; it’s yield the maturity. So, when the Fed hikes rates rather drastically in a such a short period of time, new bonds become available with a dramatically higher yield, in comparison to those bonds SVB & others were buying just a handful of months earlier – with a relatively small difference in maturity. This put the value of those bonds underwater, but that’s not what caused the problem. If SVB had been able to simply hold those bonds to maturity, there would have been no loss. However, after some prominent VC’s yelled fire in the theatre & sparked a run on the bank with depositors to pulling money out, SVB quickly tried to raise capital to cover those withdrawals, and when they couldn’t raise money, they were forced to sell those underwater bonds to cover the withdrawals. Yes, there are some things SVB should have done differently, like fill that Risk Management Officer role that sat vacant tail end of last year, and hold less in such low yield bonds, but it was the Fed’s concentrated rate hikes that pushed those low yield young in maturity bonds underwater. The bank failure was backstopped by the Federal government working with FDIC to use funds from the FDIC insurance pool to guarantee all depositors would be made whole. No tax payers dollars were used for this bail out, bank executives are being held accountable for poor risk management, and many who are often most critical of government intervention in markets agree, the administration & FDIC did an excellent job solving this potential crisis.
With respect to how all this this impacts mortgage rates, US bonds & treasuries are still the world’s safest parking for money, so SVB inspired concern surrounding regional banks has created a flight to safety with investment capital going into bonds, that demand pushes bonds prices up & yields/rates down. As a result, the past week has seen the most significant improvement to mortgage rates since the November & December CPI (inflation) reports came in lower than expected. Last week’s (3/14) CPI report came in exactly at market expectations of 6.0%, which allowed mortgage rates to hold on to gains. This week’s Fed meeting is another potentially high impact event. Wild week, but with respect to mortgage rates, they improved a bit last week and we expect inflation to continue gradually decrease and we still expect mortgage rates to be a little lower by end of this year – best guess would be mid/low 5%’.s
This past week, home loan rates improved to their lowest levels in a month in response to the closures of Silicon Valley Bank (SVB) and Signature Bank. Let’s walk through what happened as we approach the Fed Meeting next week.
“Bringin’ on the heartache, Can’t you see?, Can’t you see?” Bringin’ on the Heartbreak? Def Leppard.
SVB Failure and Rates
It’s important to remember that bonds enjoy bad news, so when word broke earlier this week that SVB was shuttered by the FDIC, home loan rates improved to their best level in six weeks. At the same time, the 2-year Note yield, which tracks Fed rate hike activity, plummeted from over 5.00% to under 4.00% in just a couple of days. This was an epic decline in rates not seen even after 9/11 or the Great Recession.
The good news (in the case of SVB and even Signature) is that bad management, failure to manage interest rate risk and a widespread desire for depositors to gain access to their funds (bank run) is what caused these banks to shutter.
In response, the Federal Reserve immediately created a line of credit and an implicit backstop to protect any depositors from any losses. This was good news and will hopefully limit any further fallout in the banking sector.
So, what does the Fed do with rates now that we have high uncertainty and contagion risk in the banking sector?
Stability > Inflation
Seeing that one reason SVB failed was in response to a rapid rise in interest rates, there is increased pressure for the Fed to limit rate hikes going forward and regain stability in the financial sector.
Just last week there was a high probability the Fed would raise rates by .50. Now just days later, there is a 75% chance of a .25% and a 25% chance the Fed doesn’t hike rates at all.
Next week’s Fed Meeting and press conference will hopefully have the markets feeling that the Fed is going to take every measure possible to ensure stability while they closely watch the pace of inflation decline.
Housing Numbers OK
It wasn’t all bad news this week. Housing numbers for February highlighted the little rate relief we saw in January and brought some optimism into February. Both Housing Starts (which is putting the shovel in the ground), and Permits (a leading indicator of future building), came in better than expectations.
This bodes well for housing in the months ahead, especially combined with the rate relief we are experiencing.
Bottom line: This week’s news in banking has changed everything as it relates to the Fed and rate hikes. The markets are suggesting the Fed will be cutting rates in the second half of the year which is a big change from the rate outlook just days ago.
Looking Ahead
Next week brings the Fed Meeting and monetary policy decision. As we shared, it appears the Fed is only going to raise rates by .25%, rather than .50% to foster stability in the financial markets and avoid contagion in the banking sector. What the Fed says will be important in bringing calm to the markets during this uncertain moment.