US Financial System Vulnerable to Market Stress Amid Silicon Valley Contagion

Following the failure of three US banks in the span of five days, which caused investors to reevaluate the outlook for US interest rates and sparked the greatest rush into bonds since at least 2008, financial market stress indicators responded significantly on Monday.

On Sunday, state officials shut down New York-based Signature Bank, two days after Californian authorities dissolved Silicon Valley Bank, a lender that mostly served start-up businesses. The cryptocurrency-focused bank Silvergate announced last week that it would also need to scale its operations.

Last week, SVB became the biggest bank to fail since the 2008 financial crisis, shocking markets all around the world. Over the weekend, US regulators intervened to guarantee SVB’s deposits, but this did little to reassure investors that there won’t be any further consequences.

Bank stock prices fell once more as investors lost confidence in the likelihood of rate increases by central banks around the world. Investor demand for European junk bonds has increased to two-month highs, while several measures of bond and equity market volatility have reached their greatest levels since October. Even gold has reached a six-week high.

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US Banking System Under Fire

Business-Silicon Valley-Market-US News
Financial market stress indicators spiked on Monday as three US banks failed in five days, prompting investors to rethink US interest rates and the biggest bond rush since 2008.

Indicators of credit risk in the eurozone and the US financial sector also increased on Monday, according to data from the money markets, which are carefully observed indications.

The so-called FRA-OIS spread, which calculates the difference between the overnight index swap rate and the US three-month forward rate agreement, increased to 11.4 basis points, its widest level since February 21. A greater number indicates increased interbank lending risk. This spread is frequently used as a proxy for banking sector risk.

US financial stocks had early trade losses, and a major bank share index experienced its biggest one-day decline since the COVID-19 crisis began in March 2020, falling as high as 8.7%.

With a drop of about 10%, European banks were also on track for their worst single-day decline in a year. Another measure of risk was the widening of euro swap spreads. The difference between two-year German bond yields and two-year euro swap rates increased by almost 20 basis points to 83 basis points, reaching its highest level since November 11.

Experts claimed that was because safe-haven bonds were in high demand. The premium on the fixed leg of an interest rate swap, which investors employ to protect themselves from rate risk, is measured using a swap spread in relation to bond yields.

German two-year bond yields decreased by more than 50 basis points, which is significantly greater than the drop in swap rates of 37 basis points. A gauge of foreign investor demand for the dollar, another safe haven, has reached its widest level in three years according to cross-currency basis swaps.

The lowest level for three-month euro swaps since March 2020 was minus 65 basis points. When Lehman Brothers fell as an investment bank in late 2008, this swap rate plunged as low as 300 basis points.

As significant as some of the changes in bond and stock prices on Monday were, economists concurred that they were more likely to be influenced by emotion than by actual SVB contagion.

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