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Don’t get your hopes up: SVB’s demise won’t lower interest rates

BusinessCryptoDon't get your hopes up: SVB's demise won't lower interest rates
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Crypto markets have experienced a surprising surge over the past few days, with bitcoin and ether rising by nearly 20% as of late Sunday. The stock market fell sharply on Wednesday morning as the banking crisis spread to Europe, but the Dow Jones Industrial Average was actually up a little more than 1% between Monday’s open and Tuesday’s close.

Within the last week came waves of bullish sentiment despite a wave of bank failures that would seem to suggest a rocky road ahead for the economy. This reflects the current “bad news is good news” environment, in which the lower the likelihood of a Federal Reserve interest rate increase — including negative news about the real economy — is bullish for asset markets.

This article is excerpted from The Node, CoinDesk’s daily roundup of the most important stories in blockchain and crypto news. You can subscribe to get the full newspaper here,

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But markets may still overlook a specific provision of the Fed’s recent bank bailouts that could undermine that conventional wisdom. The Fed has created a program called the Bank Term Funding Program (BTFP), which is all about backstopping the banks.

But the BTFP would also make it easier for the Fed to raise interest rates further.

The New and Improved Fed ‘Put’

At the most obvious level, of course, the crypto boom in equity markets and the stability of the opening week justified the Fed’s decision to designate Silicon Valley Bank (SVB) and Signature Bank as “systemically important” first-order There was a reaction. That emergency declaration suspended the normal rules of the Federal Deposit Insurance Corporation (FDIC) and allowed all deposits to be liquidated in full.

While West Coast venture capitalists have been rightly excoriated for their irresponsible panic-mongering about the consequences of a general relaxation. his precious svbIt is certainly true that short-term turmoil has been avoided to some extent. Signature’s rescue seems like good news for crypto in particular, as Signature banked some of the sector’s operators.

See also: Silicon Valley Bank and Signature Bank spark ‘too big to fail’ debate

But positive sentiment can also come, conversely, from the fact that banks collapsed in the first place. The collapse could be taken as a sign that the Fed’s aggressive interest rate hikes over the past year are having the desired effect of slowing the economy. In turn, this could mean that rate hikes will slow down or even reverse, which would be good for everyone still in the game.

This is the essence of the “bad news is good news” argument that markets hang on to every Fed shock. But the specifics of SVB and Signature Insolvency make the argument even more compelling. Banks were directly underpowered by the Fed’s interest rate hikes, which drive down the value of existing Treasury bonds, leading to large losses when banks sell those underwater bonds to cover withdrawals. have to sell.

While SVB and Signature faced industry-specific exit pressures, this erosion of the market value of pre-2022 bonds is an issue for a large number of banks across America. Continued rate hikes could make this worse and lead to more bank failures. At the same time, as we found out on Tuesday, inflation is still very much alive and well in the US, now running at 6%,

So the Fed needs to keep raising rates to curb inflation, but such increases could put more banks at risk. This looked like a trap for the Fed, and perhaps an obstacle to continued aggressive rate hikes. An attractive source of hopium, if nothing else.

keep it rolling

But the Federal Reserve has printed itself a get-out-of-jail-free card on the underwater-Treasury dilemma. This change may also constitute a large and somewhat covert federal subsidy of the entire US banking industry.

excavated in detail by Matt Levine of BloombergThe new bank term funding program, announced alongside the SVB and Signature bailouts, will offer loans of up to one year against US bonds issued before March 12, 2023. This includes bonds issued before interest rate hikes began in 2022, bonds whose market value has since gone down on the order of 10%-15% by high-yield bond issuances. Both SVB and crypto bank Silvergate were earlier forced to take huge losses on bond sales when customer withdrawals accelerated.

The key feature of BTFP is that it will offer loans against those underwater bonds at their face value instead of their current market value. It appears that banks are being offered a bridge between volatile, old, low-yielding bonds and safe land.

The term of the loan is notably just one year, which isn’t exactly generous, so at least some restraint has been displayed by the Fed here. But it still means the Fed could be taking on too much risk for banks: Three have blown in rapid succession. Some level of default on these BTFP loans seems very plausible.

That would leave the Fed holding Treasury bonds that probably won’t regain their market value for years, or even decades. The Fed is not exposed to the same duration risk as private banks, so it can hold the bonds all the way to their 10-, 20-, or 30-year maturity, when their face value can be redeemed from the U.S. Is. Treasury Department.

It would take further analysis to ascertain what costs and risks this actually effectively transfers from private banks to the Fed, and ultimately to the US dollar and the American public. For example, defaults on BTFP loans may amount to some sort of stealthy money-printing. But the BTFP certainly smells like a sector-wide banking backstop, or even a bailout, that, if nothing else, trades on confidence in the Federal Reserve.

See also: Should I keep my money in bitcoin or a bank? , Opinion

Meanwhile, the key takeaway for markets is that an interest rate hike is still entirely on the table as the new BTFP will prevent further losses for banks. This seems particularly noticeable to crypto market participants. The factors driving the current BTC and ETH rallies are still a bit opaque, but another rate hike would increase the downward pressure significantly.

The next meeting of the Fed’s rate-setting Open Market Committee is scheduled for March 22-23, a little more than a week from now. The Fed knows it has room to raise rates, but if traders miss this fact, the current crypto boom could turn into a dangerous bear trap.

The views and opinions expressed here are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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