Over the weekend, the Federal Reserve declared victory over the bank runs by announcing the Bank Term Funding Program (BTFP).
What does the BTFP do?
Essentially, this is a bailout for bank depositors. Say that your bank runs into the same issues as SVB or Signature. This basically means that everyone is trying to withdraw their money as fast as possible, and the bank has 2 issues:
1. They don’t have money on hand to give everyone their deposits back
2. The assets they have (usually Treasuries, Mortgage Backed Securities, etc.) are worth way less than they thought, so selling them results in a big loss for the bank
Here are the steps your bank can take to get you your money back:
1. Take out a loan with the BTFP using their assets as collateral
2. The loan is worth how much their assets (Treasuries, etc.) were SUPPOSED to be worth
3. The bank has to pay interest on that loan above the Fed Funds Rate (so they can’t game the system)
4. The loan lasts for a max of one year
5. The bank uses that loan to pay depositors back
The knee jerk reaction was to call the BTFP a “bailout.” However, I don’t think it’s really much of a bailout for the banks, who have to take on even more debt at higher rates anyway. In some cases, it’ll just put the banks on life support while everyone takes their deposits out, and the bank will then fail after the loan term is up.
Keep in mind that shareholders and most bondholders for SVB and Signature lost everything; that’s not what happens in a normal bailout. SVB and Signature weren’t bailed out. It was a bailout for depositors, and that’s about as far as it goes.
Personally, I think the Fed had already planned to do something like this, and that’s why the solution came so quickly. Bank assets were clearly in freefall; the price of their assets naturally goes down when rates go up. At some point, there would be panic, the weaker players would need intervention, and action would have to be taken. Just look at the unrealized losses built up over the course of 2022:
Now, here’s where things start to get controversial: I think this actually opens the door for more rate hikes.
You’re probably wondering how that’s even fathomable considering the damage that was already done by rate hikes. However, the Fed put an end to the worry that depositors would lose money. Before, the notion was that depositors would receive a minimum of $250k of their deposits if the bank failed, but now it’s been essentially increased from $250k to infinity. That means the above chart, as scary as it looks, is really a non-issue at this point (at least, from a depositor’s perspective).
The way I see it, with the risk of bank runs essentially gone, the Fed could act like the past week never even happened. The focus will be back to what it was before: bringing down CPI.
Earlier this week, we saw that total CPI moved up 0.4% in February MoM, and core CPI moved up 0.5% MoM. On a yearly basis, total CPI is still up 6% and core CPI is up 5.5%.
Most of the inflation remains in services, which will probably remain hot until we see some pain in the jobs market (and then for some time after, as CPI is a lagging datapoint). As I’ve written about many times, goods inflation is pretty much done, and in some cases has reverted to deflation.
However, the services economy remains hot due to increased credit card spending. But as I said last week, 2022 was the year of rate hikes, and 2023 will be the year of the effects of rate hikes. That means we’re going to see spending either slow down as high credit card APRs eat away at even more savings or come to a complete halt if layoffs hit. The former is definitely more likely in the short term, as the jobs market still hasn’t shown any material decline.
So far, my opinion here is totally at odds with the bond market. As you can see here, the 3 month yield (blue), 1 year yield (red) and 2 year yield (orange):
Source: TradingView
With that sharp move down over the past week, it’s clear that bond traders expect rates to come down in the near future.
Despite my opinion on this, I’m still a bit surprised the European Central Bank decided to go with a 50bp rate hike today. That’s increased the odds of a 25bp rate hike by the Fed next Wednesday to 67.9% as of this morning:
But as you can see, things can change fast. A week ago, there was an 81.6% chance of a 50bp hike, and with the current insanity going on, something else could happen between now and the Fed meeting that push the market’s expectations of a 25bp hike down to 0%.
Financial Tightening Will Continue
While my rate hike prediction is purely speculative, something I’m a lot more certain about is the fact that financial conditions will continue to tightening, putting a strain on liquidity. Going back to my original point, I don’t see the BTFP as a “liquidity booster.” It’s merely extending a relatively unfavorable option to banks that want to assure depositors that their money is safe.
I think this could actually be a catalyst for banks to stop lending out as much money, which they were already doing to begin with:
That chart shows that 44.8% of banks tightened their lending standards to large/mid-sized commercial/industrial companies in Q1. It’s even worse for smaller, more speculative companies. That’s a big deal, and it’s been a very overlooked consequence of rate hikes so far. Companies have gotten addicted to debt, and now they have two problems to deal with:
1. Fewer banks want to lend to them
2. The banks that do lend to them will charge them higher interest
Without the availability of low-rate (“free”) money in the system, conditions will continue to tighten, and I think we’ll start to see corporate defaults/unemployment begin to tick up by Q4, and I highly doubt the government will come to the rescue. I know it’s not exactly a popular thing to talk about, but it’s what the Fed wants to happen, and therefore we should be aware of it.
Finally, this just reiterates my opinion that debt-burdened, growth-less “safe havens” will get hit hard this year, especially if rates stay high. Quality (positive cash flow, low-debt, high cash, etc.) growth stocks may go lower with them, but if you’ve got a long-term outlook, I fully believe that’s the smart play right now. If you’re interested in which stocks I’m talking about, I reviewed all their Q4 earnings reports in the following newsletters:
2/10: PINS, ENPH, UBER, CCJ, PRLB
Disclaimer: Everything presented on my Substack is based on my personal research and opinions, and it should never be taken as investment advice. Just because I say good things about a stock or crypto or any investment doesn’t mean it’ll go up (although I wish that were the case). Any action that you take after reading anything on my Substack is your own responsibility.
Knowledge Drop!
Yes everything is falling briskly including food