A Federal Reserve rate hike next week looks much less likely as bank stocks and the broader S&P 500 resumed their fall on Friday after a one-day reprieve. Even shares of First Republic Bank tanked, as optimism quickly faded after Thursday's $30-billion rescue bolstered confidence.
The Fed and other regulators pulled out multiple bazookas last weekend to stem an incipient banking crisis, but came up short. Then the nation's biggest banks tried riding to the rescue. Bank of America, Citigroup, JPMorgan Chase and Wells Fargo each deposited $5 billion with First Republic, and six other banks added a combined $10 billion. That was supposed to end a panic leading customers to withdraw uninsured deposits over $250,000.
$30 Billion Slows Banking Crisis For A Day
On Wednesday, S&P Global and Fitch Ratings had cut their credit rating for First Republic to "junk" status with potential for further downgrades. Both cited elevated risk of deposit outflows after the failure of SVB Financial Group and Signature Bank. Fitch noted that First Republic's high concentration of wealthy and financially sophisticated customers in coastal markets gives it an unusually high share of uninsured deposits "that can be less sticky in times of crisis or severe stress."
After a report that First Republic was considering a potential sale, FRC stock continued to crater on Thursday morning — before the big-bank rescue squad arrived. Yet the fire hose of big-bank cash couldn't wash away some serious doubts.
In a Friday note, Wedbush analyst David Chiaverini cut his price target for FRC stock to 5 from 140. With a potential "distressed M&A sale" on the table, Chiaverini said holders of common stock may be left with nothing.
FRC stock sank 33% on Friday. PacWest Bancorp was another big loser, tumbling 19%. Even big bank stocks came under pressure. JPM stock and Wells Fargo both fell nearly 4%.
Bank Crisis May Deepen
There clearly seem to be some holes in the bank rescues rolled out so far. Are banks other than First Republic which have seen deposit outflows going to get their own injection of big-bank funds?
The continued fall in shares of community and regional banks is hardly an advertisement for the banks' stability and may encourage uninsured depositors to bolt to the sturdiest institutions.
On Tuesday, Moody's downgraded its outlook for the whole U.S. banking sector. The ratings firm said it expects banks to raise their deposit interest rates to avoid outflows, a negative for profitability.
Meanwhile, loan delinquencies are expected to rise as the economy weakens amid high interest rates. Banks also are expected to face losses on commercial real estate loans with office buildings already grappling with high vacancy rates because more work is being done from home.
In other words, the cracks in the ice remain, and there's a good chance they'll get bigger.
Even before SVB's crash, the Fed's loan survey revealed tighter lending conditions late in January. That should contribute to slower growth and lower inflation ahead.
As it stands, the Fed will have to be extremely careful to avoid a deeper banking crisis, and a sensible first step would be to stop raising interest rates.
Federal Reserve Rate-Hike Odds
As of Friday afternoon, odds of a quarter-point Fed rate hike next Wednesday slid to 63% from around 80% a day earlier. Meanwhile, odds of a subsequent rate hike on May 3 tumbled by more than half from the prior day and now stand around 25%.
Now Wall Street sees Fed rate cuts starting by July, if not sooner. By the end of the year, markets expect the federal funds rate to fall below 4%.
The banking crisis has clearly upended the Fed's plan to keep interest rates higher for longer.
Until last week, Fed officials insisted that the costs of hiking too little easily outweighed the costs of hiking too much. The Fed figured it could always slash rates to resuscitate the economy if overtightening precipitated a downturn. But with the sudden evidence of banking-sector fragility, the risks now look more balanced or maybe even tilted the other way.
Fed policymakers probably haven't decided yet whether to push through another rate hike next week, wrote Pantheon Macroeconomics Chief Economist Ian Shepherdson on Wednesday, a day after the stronger-than-expected CPI inflation data.
"It is more important, in our view, not to take risks with the stability of the system than to reassert your determination to fight inflation," Shepherdson wrote.
He expects the decision to hinge on whether financial markets remain volatile, which may depend on whether officials have another trick up their sleeves.
S&P 500 Rallies, Treasury Yields Rise
The S&P 500 fell 1.1% in Friday stock market action. The S&P 500 slipped back below its 200-day moving average on Friday after retaking it with Thursday's 1.8% bounce.
Meanwhile, the 10-year Treasury yield slid 17 basis points to 3.41%, near a six-month low.
Through Thursday, the S&P 500 had climbed 10.7% from its bear-market closing low on Oct. 12, but remained 17.4% off its record closing high in January 2022.
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Fed, FDIC Banking Fix
The Fed, FDIC and Treasury Department moved last weekend to shore up confidence amid the failure of SVB and Signature Bank by announcing that customers with uninsured deposits above $250,000 wouldn't lose a penny. That avoided a possible full-fledged national banking panic.
At the same time, the Fed announced a one-year bank term funding program to address a key problem that had plagued SVB. Faced by deposit outflows, SVB had to cash in billions in low-yielding government-backed mortgage securities whose value had tumbled as interest rates spiked over the past year. That left a big hole in its balance sheet.
Under the new Fed program, banks can put up their fallen government bonds and mortgage securities as collateral for low-cost Fed loans based on their initial or par value. That will allow banks to avoid selling at a deep loss if they need cash and instead hold the bonds until they reach maturity. JPMorgan expects the Fed program to provide $2 trillion in liquidity to banks, even if the biggest banks don't tap it.
Yet those moves don't appear to have entirely forestalled a crisis in confidence among uninsured depositors. While bank regulators invoked a systemic-risk exception to protect uninsured deposits at SVB and Signature, it's not certain they'll do so when the next bank fails — unless its a major bank whose collapse could crash the whole banking sector.
The message from the government, Sen. James Lankford, R-Okla., told Treasury Secretary Janet Yellen in a Thursday hearing: "You're fully insured no matter what the amount is if you're in a big bank." That has encouraged deposit outflows from community banks in Oklahoma, he said.
Time For Universal Deposit Insurance?
The simple, powerful way of avoiding the risk of contagion and a deposit flight to the biggest banks would be for the FDIC to temporarily guarantee all uninsured deposits. Former FDIC Chair Sheila Bair backed such a move in a Reuters interview on Thursday. She also said the Fed should "hit pause" on rate hikes.
However, a blanket deposit guarantee would require the FDIC and Treasury to seek authorization from Congress. Therein lies a potential problem. If Congress mulls such a sweeping move but rejects it, that might shake confidence even further. It would be like a replay of the failed first House vote in 2008 for the Troubled Asset Protection Program.
Republicans carried the ball for small and midsize banks in 2018, passing legislation that watered down the 2010 Dodd-Frank financial reform regulations. Former Rep. Barney Frank, D-Mass., who was actually on the board of the failed Signature Bank, has said that deregulation, though it exempted most banks from Fed stress tests, didn't open the door to the current problem centered on fallen government bonds.
It's not clear if the House-led GOP would back sweeping deposit guarantees, especially when Democrats are talking about tightening back up bank regulations. If members of Congress are going to take such a step, it might take even more volatile stock market action to convince them.
