Two the Point — Silicon Valley Bank & the Federal Reserve’s Newest Problem

Last week we talked about the Federal Reserve’s (Fed) likely future monetary policy path. This week we will do the same, but now through the lens of the Silicon Valley Bank (SVB) collapse. What happened with SVB has been well covered, so rather than rehash those details, we will review the Fed’s latest predicament – will they react to the uncertainty caused by SVB’s failure by pausing rate hikes next week or continue to fight inflation with additional rate increases?

The bond market is telling us that there is a 50% chance the Fed does not increase interest rates next week.  Our job is not to judge what action by the Fed is most appropriate. Rather, we must assess what is likely and how financial markets would react. As of this writing, we believe the market may be overestimating the probability of a pause in rate hikes. For example, the two-year U.S. Treasury yield has fallen from 5.06% to 3.75% in just a week!

Arguments for why the Fed should “wait and see” are becoming louder as fear about the stability of certain banks lingers in the market. Again, whether prudent or not, we believe the Fed may stay the course with a 25bp rate increase. A few reasons to consider:

  • Still evidence of sticky inflation. Services excluding shelter & medical jumped +0.9% m/m, the most since April 2022. It’s running at 7.6% y/y.
  • It is highly unlikely the Fed believes its job is done relative to inflation. A pause may signal to the market that they are done hiking – probably not something they want.
  • Might the Fed worry that a pause would indicate the other measures put in place to backstop depositors are not sufficient, increasing anxiety around the safety of bank deposits?

To be sure, both a pause and a hike are on the table, but the market may be overestimating the probability of a pause. If the Fed chooses to stay the course, interest rates would likely jump, and stocks would likely come under additional pressure.  

Source: FactSet; Bryn Mawr Capital Management