In this market review, we'll examine one of the most significant weeks in finance since the Great Financial Crisis in 2008.
You can visit the previous market review here.
We are in the eye of the biggest financial storm since 2008, which reached a critical point towards the end of the previous week. Silvergate (SI), Silicon Valley Bank (SIVB), and Signature Bank (SBNY) all failed, causing widespread concern about financial contagion. By market close on Friday, SI, SIVB, and SBNY had drawdown 99%, 95%, and 80% from their respective all-time highs.
The banking crisis sparked fear within the broader market. The Russell-2000 index suffered a severe drop of -8%, while both the Dow Jones Industrial Average and the S&P 500 gave up most of their gains from 2023, experiencing a decline of approximately -4.5%. In contrast, the Nasdaq-100 experienced a smaller reversal of -3.7%. It remains in positive territory for the year.
In 2020-2021, Silicon Valley Bank purchased US Treasuries when interest rates were almost zero. The interest rates have surged to 5%, causing a significant decrease in the market value of these bonds. As a result, when depositors attempted to withdraw their funds, the bank experienced a classic bank-run. They were forced to recognize enormous losses on their bond portfolio. Silicon Valley Bank eventually failed to have sufficient cash to meet customer withdrawal demands.
The rise in interest rates is putting huge pressure on the financial system. It looks like a Fed pivot might be coming earlier than originally anticipated, given the turmoil in the banking system. The market is expecting rate cuts by the year end, with a probability of 92.8% by December 13, 2023, according to the CME Fed Watch tool.
In the meantime, the U.S Federal Reserve announced emergency measures to guarantee deposits of Silicon Valley Bank’s and Signature Bank’s customers. The Fed announced that it will make up to $25Bn available to US depository institutions, essentially backstopping losses on U.S. Treasuries, agency debt, and mortgage-backed securities.
These bank failures are the biggest since the Great Financial Crisis of 2008. While none of these banks were considered “Too Big to Fail”, they were big enough to cause contagion in the markets. SIVB and SBNY were the 16th and 28th biggest banks when measured by assets. The combined assets of SIVB, SI, and SBNY is $330 billion, about 50% of Lehman Brothers in 2008.
The Fed’s intervention may have curtailed the banking sector’s distress in the short term but they are stuck with a dilemma that involves two unpleasant alternatives.
It seems that the sought after “soft-landing” is becoming an unlikely possibility.
Last week, we compared the current bear market with that of 1973 and 2008 drawdowns. We are going to expand our analysis. We've plotted the 2023 and 2008 drawdown, VIX, and risk-free rate data below. As we can see, the current bear market shares some similarities from that of 2008. During the GFC, rates were falling alongside the market. However, rates have been rising quickly in this bear market. The VIX (volatility index) spiked following the failure of Lehman Brothers and we’ve also seen a massive uptick in the VIX this past week, going from $19 to $26.
The contagion did not stop at trad-fi. Silvergate, Silicon Valley Bank, and Signature Bank all served cryptocurrency companies in the USA. Last year, the Terra-Luna UST ponzi collapsed into a stablecoin death-spiral, evaporating tens of billions worth of value on the Terra network.
Crypto investors are acutely aware of the impact of a stablecoin depegging event. USD Coin (USDC) is digital stablecoin pegged to the USD. Each USDC is backed by one dollar or a dollar-denominated asset with equivalent value held in accounts at regulated U.S. financial institutions. They held $3.3Bn or about 8% of their reserves at Silicon Valley Bank. USDC began to depeg shortly after the news of their exposure broke. The value of 1 USDC fell as low as $0.88 before the Fed’s intervened and it rallied back to $1.
Bitcoin maximilalists have been shouting about the benefits of decentalisation and self-custodianship for years now. They have been waiting for an opportunity like the one that just presented itself, for the asset to shine. Going into the weekend, Bitcoin dropped below $20k for the first time since January. It has since rallied over 30% to ~$26,500.
There are a few reasons why Bitcoin might have risen at the weekend, including
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