From the Desk of Ian Culley @IanCulley
US bank stocks big and small took a beating Thursday, with the Bank ETF $KBE posting its largest single-day decline since 2020.
The steep sell-off came on the heels of Silicon Valley Bank’s $SIVB Wednesday announcement of a $1.8B loss, mainly due to accepting unrealized losses in US Treasuries.
Based on SIVB’s acute exposure to the tech industry, you can argue larger banks with more diversified portfolios and clients don’t carry the same risk. And they don’t.
Regardless, the next chart reveals a storm brewing beneath the surface...
Check out bank stocks (KBE inverted) overlaid with the US Treasury 2s10s spread:
I inverted KBE to highlight the strong relationship between banks and the yield curve. The two lines look almost identical over longer timeframes.
The main takeaway: Banks do not fare well when the shorter end of the curve outpaces the longer end.
Why? They hold heaps of government debt across the curve – especially shorter durations.
Remember, treasury bonds are considered risk-free. Providing one can hold the asset until maturity.
That’s the problem SIVB came up against. Their balance sheet largely consisted of short-duration government bonds. And as they ran out of cash, they were forced to realize almost $2B in losses.
Again, larger financial institutions – such as Bank of America $BAC, JPMorgan $JPM, or Charles Schwab $SCHW – lack the same exposure to risk as SIVB. But they’re still sitting on significant unrealized losses.
Bonds became risk assets for individual investors last year. Fast forward to today, and financial institutions are also feeling the pain.
We’ll need to wait to see if the fractures at the margins revealed by SIVB run to the heart of the banking sector.
Nevertheless, today’s chart raises legitimate concerns regarding the risks posed by an inverted yield curve and a relentless rise in rates.
Stay tuned.
Countdown to FOMC
Following the recent 25 bps hike, the market is pricing in a double hike at the March meeting.
Here are the target rate probabilities based on fed funds futures:
Click the table to enlarge the view.
This data is from the CME FedWatch Tool as of March 9, 2023.
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