March 20, 2023 | 2 MIN READ

Weekly Market Update

Unintended Consequences

What happened last week?

  • The S&P 500 gained 1.43%
  • The Dow Jones slid -0.15%
  • The Nasdaq composite increased 4.41%

The largest US banks deposited $30 billion with First Republic Bank to help stem the recent outflow of deposits at regional banks in a show of faith. The move came days after officials acted to protect the depositors of Silicon Valley Bank and Signature Bank.

This week the market will focus on the March 22 Federal Reserve Meeting. The market is discounting 67.2% odds that the Fed will raise rates by 25 basis points to a 4.75%–5.00% range, according to the CME FedWatch Tool.

3 Things to Know

Confidence is critical

Confidence is critical to the banking system and to the economy’s performance. Once a financial institution loses the confidence of its customers, it becomes vulnerable. This past week, we have seen what a lack of confidence looks like in internet time.

Within days, we saw the failure of two large banking institutions. Unlike in 2008, the speed of information has impacted the speed of depositor actions to the point where regulators had to act intraday to announce bank closings.

This past week, a consortium of US banks deposited $30 billion at First Republic. When there are enough events like bank failures or forced mergers between institutions, depositor and investor anxiety — the antithesis of confidence — can become endemic.

We have already seen the price of regional bank shares in the US fall by 30% since March 1.

On March 15, bond rating agency Moody’s cut its outlook on the US banking system to negative due to a “rapidly deteriorating operating environment.” Moody’s issued its warning after US regulators had stepped in to ensure the safety of depositors and promised to provide substantial liquidity to banks faced with deposit outflows.

The Fed’s abrupt and rapid reversal of monetary policy set the stage for today’s unfolding events. Following record stimulus in 2020 and 2021, the Fed reversed course in 2022 and raised rates 450 basis points, more quickly than ever before while also reducing its bond portfolio at a rapid pace.

They have committed to maintaining these policies until their target of 2% inflation is in sight. This reversal of policy and abandonment of incremental action in 2022 saw the worst combined stock and bond market performance since 1931.

The fact that banks have $620 billion in aggregate mark-to-market losses on their securities portfolios is, in part, a reflection of the Fed’s actions.

A week ago, the FDIC, Federal Reserve and Treasury Department stepped in to ensure that all depositors of Silicon Valley Bank and Signature Bank — both insured and uninsured — would have “full access to all of their money starting Monday, March 13th.” They implied that all depositors at US banks wouldn’t be subject to default.

But are all US bank depositors safe? Of any size? Is there, in fact, unlimited deposit insurance, if only during this period of massive instability? That remains unclear.

Implications for depositors, regulation, and the economy

Regardless of the timing of the end of 2023’s banking emergency, there are several impacts that will extend to the broader economy with delayed, but negative implications.

The rates banks will need to pay for deposits will rise while US Treasury rates will fall. Borrowing costs for companies and individuals will rise, as well. Market liquidity will be reduced.

The behavior of bank depositors will likely change and their awareness of available rates from other sources will become a part of their “buying process,” as will considerations of relative safety.

All of this will put pressure on bank profitability over the coming year or longer. And in the meantime, there will likely be more banking consolidation and less credit expansion.

There will also be regulatory changes. While US employment gains have been stronger than expected in the early months of 2023, we continue to believe the extreme Fed tightening cycle is sure to apply the brakes, and not evenly. Less well-capitalized firms (cash-burning small caps) and industries under secular pressure (such as office real estate) would likely be the first to show cracks.

Citi Global Wealth Investments
Charlie Reinhard - Head of North America Investment Strategy
Lorraine Schmitt - North America Investment Strategy

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