Impact of Silicon Valley Bank failure also felt in Tokyo market

On March 13, the Tokyo market was strongly affected by the collapse of Silicon Valley Bank in the U.S. at the end of last week. Following last Friday, bank stocks sold off sharply, and the Nikkei Stock Average temporarily dropped more than 500 yen.

The risk aversion trend is also strongly reflected in the bond and foreign exchange markets, with the yield on 10-year JGBs falling to 0.32%, the lowest level since December 20 last year when the Bank of Japan revised its yield curve control (YCC) and raised the yield on 10-year JGBs by increasing the yield volatility range. Further, reflecting the revised outlook for U.S. monetary policy and growing risk aversion due to credit concerns, the yen has appreciated against the dollar in the foreign exchange market, temporarily reaching the mid-133-yen per dollar level for the first time since mid-February.

Risk of panicked deposit withdrawals causing a chain of bank failures

The collapse of Silicon Valley Bank exposed the increasingly fragile earnings environment for U.S. banks amid the Federal Reserve’s push to raise interest rates sharply.

While not using public funds to bail out the bank, U.S. financial authorities took the unusual step of fully protecting the bank’s deposits, thereby containing the risk of a chain reaction in which high-tech startups that had lost their deposits would go bankrupt, which would in turn hurt other financial institutions. Furthermore, the Fed did not bail out the bank by providing liquidity, but decided to provide an emergency loan to the bank as a whole.

The failure of Silicon Valley Bank is not likely to directly deal a huge blow to the business environment of other U.S. banks or banks in other countries, including Japan. However, there is a risk that once confidence in the financial system is undermined, it could trigger a chain of failures.

Proactive measures to curb the trend of deposit withdrawals

The most alarming prospect of the Silicon Valley Bank failure is that depositors who hold more than the deposit insurance coverage limit of $250,000 with other banks, fearful that they will not be able to recover their deposits in the event of a chain of bank failures, will withdraw their deposits in large quantities. The actions of such anxious depositors could lead to a chain of bank failures. The authorities’ decision to take the exceptional step of providing full deposit protection in the two cases of Silicon Valley Bank and Signature Bank appears to have been intended to create the expectation that this exception will apply to other banks as well and that deposits will be fully protected, thereby discouraging the withdrawal of deposits.

Furthermore, the FRB’s emergency loans are intended to demonstrate its function as a lender of last resort to prevent healthy banks from failing as a result of panicked deposit withdrawals. The ultimate intention here is probably to curb the trend toward deposit withdrawals.

Speculation over Fed rate hike postponement also emerges

Despite this proactive response by U.S. authorities, credit concerns have continued to smolder in the financial markets after the beginning of this week. Moreover, the situation has also changed the FRB’s monetary policy outlook.

It should be noted that on March 13, the yield on the 2-year U.S. Treasury note fell again in the Tokyo market by more than 0.2 percentage points from the close of last week in the U.S. market, to around 4.35%. This marks a sharp drop of around 0.7 percentage points in just three business days, from around 5.07% on March 8. This turn of events reflects growing credit concerns and risk aversion in the financial markets.

Furthermore, the FRB’s monetary policy outlook has been revised in tandem with this risk aversion trend. As of Wednesday, March 8, it was generally believed that the FRB would make a larger rate increase of 0.5% at the next FOMC meeting on March 21 and 22.

However, by Friday the 10th, following the failure of Silicon Valley Bank, the view that the rate hike would be 0.25% became dominant. Furthermore, at the beginning of the new week, on the 13th in Tokyo, the market was noticeably factoring in the possibility that the FRB would not raise interest rates in March. At this point, the federal funds futures market appears to be factoring in the view that the policy rate will remain unchanged at the March FOMC meeting, followed by an additional 0.25% rate hike heading towards May, after which the rate hikes will cease at around 5%. A rate cut of about 0.25% toward the end of this year is also being factored in.

Diminishing expectations of FRB rate hike leads to speculation that BOJ will postpone policy revisions

Diminishing expectations of a FRB rate hike will also affect the BOJ’s monetary policy outlook from April onward. With the growing expectation in the financial markets that the FRB will move up the timing of the end of its rate hikes and the timing of its rate cuts, expectations will also grow that the BOJ will postpone further revisions to the YCC and the end of its negative interest rate policy, either of which would entail further rises in long-term yields. This is because such measures would increase the risk of a rapid appreciation of the yen.

The large decline in the yield on 10-year JGBs in the Tokyo market on March 13 may have been influenced by the BOJ’s revision of its monetary policy outlook, in addition to risk aversion reflecting credit concerns. Furthermore, the large decline in bank stocks on the same day may have been influenced not only by the credit concerns originating in the U.S., but also by fears that the BOJ’s postponed policy revisions will further delay improvement in the margins of Japanese banks.

Concerns that this time the FRB will not save the financial markets

Diminishing expectations of a FRB rate hike should have the effect of easing credit concerns in the financial markets, but this cannot be clearly confirmed at present.

What financial markets are concerned about is that, if an economic or financial shock occurs, the FRB will not take aggressive measures this time around, such as cutting the policy rate to zero all at once, as it did in the Lehman Brothers collapse and Covid-19 crisis. This is a consequence of historically high inflation, and it is possible that the FRB will continue to take a cautious stance toward large rate cuts to prevent the upward trend in inflation from taking hold. In the past, the FRB’s aggressive easing has saved the U.S. and global economies and financial markets in times of major shocks, but the view that the FRB cannot be expected to fulfill this role this time is perhaps also amplifying the turmoil in financial markets.

U.S. economic slowdown may elevate credit concerns in earnest

Furthermore, it is possible that even if the slowdown in the U.S. economy becomes more pronounced going forward, the FRB may decide not to cut interest rates aggressively, thereby further elevating concerns about the economic outlook and actually worsening the economic situation.

Although the collapse of Silicon Valley Bank is not expected to rock the U.S. banking system in one fell swoop, if the impact of the FRB’s sharp interest rate hikes up to now were to be combined with a worsening economic situation in the future, then distrust of the banking system and financial market turmoil could be triggered in earnest by speculation over deterioration of the earnings environment for banks and heightened management vulnerabilities. That, in turn, has the potential to evolve into global credit instability and financial market turmoil.

• Takahide Kiuchi

  Executive Economist