Banks are starting to fear the Fed’s restrictive policy and the knock-on effects on their balance sheets (not compensated by high margins).
The next Wall Street crisis will start from the banks. The triggering event is the increase in interest rates which, months later, is putting the financial sector and the entire economy to the test.
After 15 years of artificially low rates, the transition to a reality in which the cost of money will remain high for a long time raises concerns and uncertainties in the financial markets, but the problem goes far beyond stock market volatility.
Increasing risk for the banking sector
There are various sectors of the economy exposed to the risk of higher interest rates, but the banking sector is one of the most vulnerable.
Already a first sign of difficulty arrived at the beginning of this year with the bankruptcy of some American regional banks (including Silicon Valley Bank), which had accumulated too much debt in the long term, forcing them to sell these assets at a loss due to the run on deposits.
In the second quarter, unrealized losses on banks’ balance sheets increased by 8.3%, reaching a staggering $558.4 billion, according to the Federal Deposit Insurance Corp. Most of these losses are attributable to held-to-maturity Treasury securities, the value of which has been dramatically reduced due to rising interest rates.
This situation is destined to worsen further, with additional rate increases. When banks’ capital is under pressure, any weakness becomes even more problematic. If further losses occur, banks could be forced to issue new shares, diluting the value of existing ones and putting further pressure on the sector. This has already been reflected in bank stocks, with the SPDR S&P Bank ETF falling nearly 30% from its February peak and 40% from its late-2021 record.
Looking at the ETF graph, we note the potential risk of a further 20% decline, until the trendline tests rising from the 2009 bottom.
Peak rates and financial stability
The current phase of rising interest rates is raising concerns about the stability of the banking sector in the United States. A report from the Social Science Research Network (“Monetary Tightening and US Bank Fragility in 2023: Mark-to-Market Losses and Uninsured Depositor Runs?”) identified 186 banks at risk of failure or collapse due to rising rates and uninsured deposits. This scenario could trigger a domino effect, endangering other financial institutions and leading to a credit crunch that would hinder access to credit for businesses and consumers, slowing economic growth. Furthermore, a bank run at these vulnerable banks could become widespread, threatening confidence in the banking system and potentially triggering a recession or financial crisis. The situation requires urgent attention to avoid a negative impact on the economy as a whole.
Consequences on the markets: forecasts for the S&P 500 index
The banking sector crisis could drag down the entire market represented by the S&P 500 index. From a graphical point of view, the Wall Street benchmark index has already completed a bearish head and shoulders with the violation of the neckline at 4,350 points. Before reaching the figure’s target (at 4,050-4,075 points), prices could attempt a pullback towards 4350, testing the neckline from below. Only a stable return above 4,350 would prevent the realization of this scenario, favoring a recovery towards 4,440 points.
Original article published on Money.it Italy 2023-10-05 16:47:39. Original title: Perché la prossima crisi di Wall Street partirà dalle banche
