Jason's World

In March, the collapse of Silicon Valley, Bank, and First Republic bank sent jitters throughout the banking industry that eventually were quelled thanks to larger players, First Citizens and JPMorgan, who stepped in and took over their business. For a while it seemed that what happened in March was merely a purge of players who weren’t doing things correctly, who were taking too much risks. Both Silicon Valley made loans without considering the possibility that the interest rate would eventually rise. 

Since the relatively small scale panic in March, investors have been buoyed by stronger than expected economy, a growing interest in the rise of AI, and lower than expected inflation. The panicked days of March became an afterthought-in five months time, we went from staring down the next 2008-style crisis to the roaring 20s as tech roared back owing to the focus on AI and its implications that was spurred by Nvidia.

Recent events indicate that trouble may once again linger on the horizon. After months of better than expected inflation and a stronger than expected economy, cracks are emerging in this narrative of a indomitable US market-and the panic may be worse than what happened in March.

Last week, Fitch downgraded the credit rating of the United States, the second such downgrade buy any credit agency since the turn of the century. More recently, Moodys downgraded 10 regional lenders and put six other much bigger ones, like Capital One and PNC, on warning.

This once again brings talk of financial collapse back to the forefront as investors rehash memories of the widespread fears that gripped the markets five months ago. However, there are a few factors that will make the impending panic much worse than the panic in March.

The aggregate scale of the banks that were skewered by Moody’s recently are much bigger than the banks that failed back in March. M&T Bank, the largest bank to receive a downgrade, is roughly the size of Silicon Valley Bank. Some of the largest banks in the US were among those who received a downward adjustment in outlook: US Bancorp, PNC, and Capital One. These three banks alone are three times the size of First Republic, Silicon Valley, and Signature put together.

The federal funds rate is at a higher rate than it was back in March-and there are indications that they will only continue to remain there if not rise further with a Fed skeptical of the notion that inflation is under control. 

There is one data point that investors should find especially discomfiting ahead of the inflation report tomorrow-gas prices have risen more than 7% from four weeks ago. At a time where trillions of dollars of low-rated corporate debt and commercial real estate debt are at an elevated risk of default, and when the banking industry is under ever increasing pressure, all because of a hawkish Fed, the last thing that investors would want to see is a Fed actually being right on inflation-and right now, the uptick in gas prices serves as early evidence of that. If tomorrow’s inflation report comes in higher than expected, this will be a perfect rationale for the Fed to push the banking system, and with it, the economy as a whole, further to the edge. 

If that happens, then no one should be shocked when the Fed ends up raising rates-and what happens after that will probably be a little scary for me to mention.