Cracks are starting to show in the global financial system as the era of cheap money comes to an end. Investors are worried that the recent collapse of Silicon Valley Bank could signal a time of reckoning for world markets. Over the past year, the US Federal Reserve has launched its most aggressive interest rate hiking cycle since the early 1980s, and other central banks have followed suit. This has left global investors facing a range of consequences.
They have seen the longest selloff in technology shares since the dotcom bubble at the turn of the millennium, a collapse in the cryptocurrency industry, a run on US and British real estate funds, and an intervention by the Bank of England to prevent a near-collapse of British pension funds.
Following the second largest bank failure in US history on Friday, market participants worry that more disruptions could be on the horizon. Climbing interest rates are cutting off access to cheap money and exposing vulnerabilities in the economy. Big investors, including Kyle Bass and Bill Ackman, argue that the government must take quick action to avoid Silicon Valley Bank’s collapse sparking more widespread withdrawals in the banking system.
So far, the pain has been largely felt by investors and institutions that placed risky bets. It remains to be seen whether the pain spreads to others, and a new crisis emerges. That could be determined by how hard the world’s central banks continue to push interest rates higher.
Federal Reserve Chair Jerome Powell has reaffirmed his message of higher rate hikes but emphasized that the debate is still ongoing, depending on upcoming data. US officials have also argued that the banking system is robust.
However, signs of market unease have grown in recent days. The S&P 500 fell 4.6% this week, almost erasing its gains for the year, while the Cboe Volatility Index, known as Wall Street’s fear gauge, surged to its highest level in three months. Yields on two-year Treasuries saw their biggest plunge since the 2008 financial crisis. This suggests a flight to safety among investors, as well as bets that economic distress may force the Fed to ease up or reverse its aggressive tightening.
California banking regulators shut down Silicon Valley Bank on Friday after the bank, which had $209 billion in assets at the end of 2022, saw a run, with depositors pulling out as much as $42 billion on a single day, rendering it insolvent. Similar to the UK pension fund crisis in September, the firm appeared to be on the wrong side of the surge in yields, leaving it exposed to interest rate risk and unable to meet its liabilities.
The fallout has hit a number of companies who did business with the bank. In the latest, Stablecoin USD Coin (USDC) lost its dollar peg and slumped to an all-time low after Circle, the US firm behind the coin, revealed that a chunk of the reserves backing it were held at Silicon Valley Bank.
The bank’s failure will likely increase pressures on companies to become profitable, ending the era in which investors were willing to withstand years of losses for the sake of expanding market share.
