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SVB Fallout and the Fed’s War on Inflation – Where This Leaves Investors

14 March 2023

by: EG Fisher, Partner and Chief Investment Officer, Mariner Investment Group, LLC

Only a few trading days into the current regional banking crisis that culminated with the closures of Silicon Valley Bank and Signature Bank and met with decisive action by the Federal Reserve, it’s safe to say that the investment horizon for investors is now significantly more complex than it appeared just days ago. In the weeks and months to follow this cataclysmic shock to the banking sector and to the economy, we expect to see a continued increase in volatility across fixed income as well as most other asset classes.

The funding program and depositor backstop that the Fed put in place on Sunday are highly supportive of the banking sector and enormous in size – of a magnitude akin to its COVID response. More specifically, the funding mechanism will allow banks to fund treasury and mortgage-backed agency securities at OIS + 10 basis points. In addition, the Fed will permit banks to fund at par the value of their securities as opposed to their current market value, giving the banks badly needed cash for their collateral.

With respect to the broader repercussions of these events, we anticipate that they will have a net negative economic impact and will alter the Fed’s expected rate path, as well. Our view is that the Fed will likely raise rates by 25 basis points at next week’s Fed meeting, but that this or the Fed’s May meeting may be the last of the rate hikes. We do not believe the Fed funds rate will get to 5.70%, which is where they were priced before the onset of this current crisis. At the same time the Fed must still grapple with structural inflation. Just this morning the Consumer Price Index print came in relatively high, up 0.5% month over month and 5.5% year over year at the core level. How this will all shake out over the coming months remains to be seen.

Fixed Income Relative Value Strategies – A Haven of Opportunity in a Tough to Read Market

We have three key takeaways for fixed income relative value investors from our initial analysis of the events over the past several days:

  1. Volatility Has Spiked – As of today the MOVE Index hit a new post Lehman high of 173, eclipsing its previous recent high of 160 on October 12 of last year. Whereas we had initially anticipated that volatility would be in the range of 80-110 on the MOVE index for the year, we now believe that given the uncertainty around the economic impact of these changes to the banking regime, volatility will now fluctuate in the 100-130 range over the next three months.

  2. Change to the dynamic and supply of trade flow – Regional banks, forced to hold fewer assets, will need to reposition their portfolios, selling more treasuries and mortgages. This in turn will lead to a big increase in trade flow volume and volatility, opening up opportunities in On-The-Run vs Off-The-Run spreads, cash vs futures basis trades, yield curve flow trades, and mortgage basis trades.

  3. Increase in funding volatility – Recall that back in March of 2020, the Fed massively increased their balance sheet to mitigate the economic aftershocks from COVID, and funding volatility effectively went to zero. Since the middle of last year our call has been for an increase in funding volatility as bank reserves fell while the QT process unfolded. The current gyrations in the regional banking sector are at least due in part to falling reserve levels as the Fed closed the door on the era of easy money. This creates opportunities in funding volatility.

The bottom line is that we believe the SVB crisis and the Fed response have significantly altered the economic outlook, creating pockets of opportunity for the discerning fixed income relative value investor. We will continue to monitor market developments over the coming weeks and will be back to you with further commentary as these events unfold.

The Information above reflects the professional views and opinions of its author and does not necessarily reflect the views or opinion of his employer Mariner more generally. This information is being provided for general consideration and interest purposes only and is not necessarily intended to induce consideration in the possible investment in any products or services offered by Mariner, and should not be relied upon for any specific purpose.