It’s Between QT and QE

It’s Between QT and QE

By Philip Dudley

The old saying that, “The Fed raises interest rates until something breaks” has never been more true than now.

The recent collapse of Silicon Valley Bank (SVB), Signature Bank and Credit Suisse in the span of a few days are fairly significant breakages in size. The actions taken by the Federal Reserve and Swiss National Bank are even bigger.

The Fed’s balance sheet may be “running off” (a fancy term for letting their portfolio mature and not reinvesting) as they try to restrict liquidity. But the new Bank Term Funding Program (BTFP) that’s just been instituted is stimulative.

So much so, the BTFP just wiped out all of the Fed tightening year to date because $153 billion was drawn down by the banking industry. That number is larger than the liquidity needed by banks during the 2008 financial crisis. Bottom line, we are somewhere between Quantitative Tightening (QT) and Quantitative Easing (QE).

There was a serious fixed income duration mismatch at SVB that resulted in the second largest bank failure in our great country. A duration mismatch occurs when you underestimate the move in interest rates vs. your loan portfolio.

SVB reacted late to this widening gap and spooked the market when they sold their entire “available for sale” bond holdings and realized a $1.8 billion loss. Then they tried to raise equity in equal size. The market said no thank you and the bank run was on.

Where is all the money going? Well, if banks are only paying depositors a meager amount of interest on their deposits, a savvy investor (or now a scared bank depositor) will move those deposits over $250,000 to money market funds or Treasury Bills. About 97 percent of SVB depositors held deposits over the FDIC limit, so why would anyone be surprised by the outcome.

So what does all this mean for interest rates, gold and bitcoin? The fixed income futures markets are definitely telling a different story than The Fed.

The two-year Treasury Note yield traded from over 5 percent to under 4 perecent in a matter of days following SVB collapse. That was truly staggering. And the MOVE index, which measures volatility in the bond market, has spiked. The Fed is either done raising rates, or nearly done, to put it mildly. If they are nearly done, they will very likely be walking rates back in the next 12 months.

Gold performs well during periods of high inflation and financial distress, both of which we’re currently experiencing. One interesting strengthening relationship developing right now is the correlation between bitcoin and gold. The rolling 30-day correlation currently stands at .5 percent and is higher than the rolling 30-day Bitcoin and NASDAQ 100 correlation of .3 percent.

That’s interesting because Bitcoin has been viewed by many as a risk on asset, but its narrowing relationship to the movement of gold is noteworthy.

Also, the dominance of bitcoin is increasing among the crypto universe as market participants (old and possibly new) continue to seemingly accumulate as a store of value. Is “digital gold” ready to shine? Only time will tell.