The banking industry and capital markets more broadly have undergone a tumultuous period since the collapse of Silicon Valley Bank on March 10.

Despite swift measures by the Federal Deposit Insurance Corporation to guarantee bank deposits—including those above the $250,000 maximum—the events at Silicon Valley Bank eroded confidence in the entire banking industry. Smaller regional banks, in particular, have taken the brunt of the hit and are down nearly 20% in the period from March 1 to March 27.

While the crisis has caused a flight of deposits out of regional banks and into larger banks and money market funds, the risk does not appear to be a systemic threat to the entire banking industry.

On March 22, the Federal Reserve raised its target for the fed funds range upper limit by 25 basis points to 5%. The move appeared to be a concession between a 50-basis-point move and no move at all, as they balanced their fight against inflation and the still unknown risks of the turmoil in the banking industry. Prior to the Silicon Valley Bank collapse, markets were anticipating a 50-basis-point hike after the January and February inflation data came in hotter than expected.

Having learned from prior crises, the Fed acted swiftly and launched the Bank Term Funding Program, an emergency lending program that provides banks access to liquidity to help shore up balance sheets and help protect against any other potential runs on deposits.

The expansion of the balance sheet comes at a time that the Fed was pursuing quantitative tightening. However, Fed Chairman Jerome Powell has made it clear that this balance sheet expansion is temporary, intended to help banks meet “special liquidity demands,” and should not be viewed as a reversal of quantitative tightening.

Undoubtedly, the Fed’s job has gotten a lot more difficult as they are now faced with not only combatting high inflation and navigating a soft landing, but also maintaining financial stability.

Before the banking crisis, the Fed had already slowed the pace of tightening from 75-basis-point to 25-basis-point hikes, acknowledging that the lagged effects of previous tightening have yet to come through in economic data. While slowing the pace of rate hikes and acknowledging incoming data, they confirmed that rates will need to go higher and will be there for a prolonged period.

Amid fears of a slowdown and recession in the back half of the year, banks had already begun tightening lending standards, and they are now expected to further pull back on credit as they become more risk conscious, which could be turbulent for markets. 

Conclusion 

While banking stocks have sold off steeply, broader equity markets have proven more resilient and do not fully reflect the prospects for a more significant downturn in growth and earnings in the back half of the year. Therefore, T. Rowe Price’s Asset Allocation Committee remains cautious and is underweight to equities.