As we’ve approached peak rates, Q1 has been dominated by huge shifts in pricing the Fed’s approach to monetary policy. The Fed misjudged reviewing 50bp hikes just 2 days before Silicon Valley Bank’s (SVB) collapse which contributed to wild swings across the bond market not seen since 1987. Treasuries, equities and gold were all driven higher as investors price in rate cuts for 2023 and grow concerned over counterparty risk in the banking system.

So what happened in Q1? Stronger than expected labour market data in February caused a sell-off across the markets as investors re-priced rates higher, but that all reversed the day that Silicon Valley Bank (SVB) collapsed. Just two days before the collapse, Jerome Powell told the markets that the Fed might be prepared to hike the Fed funds rate by 50bps in March, from 4.75% to 5.25%. This was a mistake from the Fed who have been too complacent about the lag between policy tightening and the impact on the real economy. Never in history has the US economy avoided recession once CPI has exceeded 5%, yet the Fed brushes history aside and continues to talk up the probability of a soft landing. The soft landing view looks increasingly implausible.

SVB’s collapse marked the largest bank collapse since 2008. The reason for the collapse was poor management from SVB who placed focus on growing their deposit base as fast as possible. They invested the deposits in Treasuries in 2021 and watched the value of these treasuries lose around 20% as rates rose significantly through 2022. Interest rate hedges had been removed leaving SVB exposed to the losses that were significant enough to wipe out their equity. SVB tried to cover the losses through a legal accounting loop-hole that allows them to value the treasuries at par on the books, rather than mark them to market. However, once the market realised the extent of the true losses, depositors panicked and withdrew all deposits. The ensuing bank run killed SVB.

Treasury Secretary Yellen and the FDIC tried to calm the markets by announcing that all SVB depositors would be made whole. However, they refused to confirm that all deposits above $250k across all banks would remain safe, and that they would only act to prevent systemic risk. In other words, they would only guarantee deposits at ‘too big to fail’ banks. This leaves small banks at significant risk of losing deposits to the large banks. In the last week, small banks have suffered the largest weekly outflows of deposits in history. The panic also forced Credit Suisse (CS) underwater and regulators forced a rescue deal between UBS and CS. While I think it is likely that a number of small banks fail in the wake of SVB, I do not see a replica of the financial crisis of 2008. SVB’s mismanagement was unique to them and CS have been in a financial hospice for quite some time.

In response to the SVB collapse, the 2 year yield which had just topped 5%, dropped to 3.90% in 3 days and now sits at 4.10% as I type. The 10 year yield dropped from 4.0% to 3.40% as the 2y10y spread rose from -107bps (the most extreme level since 1981) to around -50bps. The market moved from pricing hikes this year to now pricing 2-3 cuts. This, of course, is great for gold which responded by rallying from $1800/oz to $2000/oz and rests around its highest ever monthly close. Silver rallied from $20/oz to $24/oz although it still trails gold relative to their long-term historic ratio. The gold-silver ratio (GSR) is 83 currently versus its long-term average of around 60.

You can see the impact of the SVB failure on gold and silver in the charts below.