Inflation inflection 4.0 - A Year Ago We Had a Regional Banking Crisis
This is a continuation of a series of posts on inflation. To see the previous posts, go to A New Inflation Paradigm, Inflation Inflection—Why The Market Is Likely Wrong On Inflation, Inflation Inflection 2.0—With Easing Inflation, Will The Fed Pivot?, and Inflation Inflection 3.0: What's Ahead as Inflation Rapidly Retreats?
On with the show...
A year ago, we had a regional banking crisis.
The Fed, FDIC, and Treasury acted quickly and effectively to prevent this from becoming a systemic bank insolvency contagion and a massive hit to the #startup #tech ecosystem due to #SiliconValleyBank's concentrated customer base.
Unfortunately, the underlying dynamics stressing the Banks have not gone away, like most people's memories of what happened and why.
The issues have only been papered over (asset losses on balance sheets have been filled through collateralizing 100 cents on the dollar on assets worth only 70-80 cents), kicking the proverbial can down the road.
The problem here is that the newly established Bank-Term Funding Program (BTFP), which resuscitated the banks a year ago, only gave the banks a window of time. The collateralized loans taken through this program must be paid back within one year, and the Fed shut down the BTFP program on Monday the 11th.
So, all loans taken out through this rescue program must be paid back by 3/11/2025, and the first loans taken are already being paid back. This will drain liquidity in the banking sector, financial markets, and the real economy. However, the markets already know this, so we can assume asset prices currently reflect this reality.
However, the markets' interpretation of inflation and Fed interest rate policy is subject to scrutiny. We know the fight against inflation is anything but won, yet the market is pricing in as if it has.
The CPI stopped declining eight long months ago, is stuck in the +3% range, and recent months have shown a (re)acceleration in key inflation metrics such as core inflation and core services inflation.
To expand, this week's CPI report showed that "core" inflation (CPI that excludes food and energy prices due to their high levels of volatility) came in at +3.8% year-over-year. And "supercore" inflation, which targets the rate of inflation in the service areas of the economy, came in at a whopping +4.46% and marked its 5th consecutive month of (re)acceleration.
Why does this matter? Because the financial markets and most people I know and hear from expect The Fed to begin lowering interest rates this year. Just ask your local realtor or mortgage broker.
And...
I hate to be the bearer of bad news, but The Fed will not be cutting interest rates with these inflation trends, should they persist. If they do, woof, that would be a monumental mistake as U.S. and global economic growth is projected to reaccelerate through the end of this year - and financial markets concur.
Indeed, the reasons why inflation will decline are becoming fewer and fewer by the day, while the reasons for a resurgence of inflation are becoming increasingly plentiful.
The Fed may not raise rates for a while, hoping beyond hope that their monetary policy is restrictive enough to bring inflation back down to their 2% target, but they will not cut.
So, again, why does this matter?
Because no cut means higher interest rates for longer, which in turn means the asset losses on bank balance sheets remain large and wide. And if the trend of inflation reacceleration continues, 1) the Fed may not be done raising interest rates this cycle after all, and 2) more money will continue to flow out of individuals, families, and companies' bank accounts, which puts deposit outflow stress on the banks.
Deposit outflow stress on banks means they may need to begin selling securities on their balance sheets to meet redemptions, though this time, without the BTFP, they will have to take mark-to-market losses.
And that, my dear friends, is precisely what pushed us into a banking crisis last year.
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Matt Faubion, CFP®
Founder - Wealth Manager
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