From the trader's perspective, a review of the banking crisis and an analysis of the volatility in the cryptocurrency market since the Federal Reserve's interest rate hikes

Written by: 无为BeWater@crypto

The Crisis of Small and Medium Banks Brings Market Panic

Since the Federal Reserve began raising interest rates in March 2022, it has increased rates from 0% to 4.75%-5.00% within a year, a pace of rate hikes that has been rare in the past. The rate hikes before March did indeed curb the speed of inflation and brought significant negative impacts to risk assets such as U.S. stocks and cryptocurrencies. However, prior to the liquidity crisis of small and medium banks, the Federal Reserve had not observed other negative impacts on the economy. Looking back at each rate hike, there is bound to be some destructive force (break something), and the recent crises of small and medium banks ultimately stem from the Federal Reserve's continuous rate hikes.

For banks, depositors' savings are liabilities on the bank's balance sheet; the bank's external investments or loans issued are assets. From the liability side, if there is continuous cash outflow pressure or higher yield options (higher-yielding government bonds due to rate hikes), it will inevitably lead to outflows of bank deposits, which means the repayment obligations on the bank's liabilities. From the asset side, external investments, such as MBS or government bonds, continue to decline in market value in an overall rising interest rate environment, resulting in significant unrealized losses on the balance sheet. If cash flow becomes tight and the bank needs to sell off its bond holdings at a loss, it will lead to a reduction in assets, inevitably causing more depositors to withdraw their funds. In summary, rate hikes have impacted both the asset and liability sides of banks. All banks operate with leverage, and according to Basel Accord capital adequacy requirements, they can have leverage of up to 12.5 times. Any bank with insufficient cash flow cannot escape the pressure of repayment, leading to a broader bank run among small and medium banks.

The liquidity pressure on small and medium banks, combined with the crisis of the systemically important bank Credit Suisse, has created widespread panic in the market. The S&P 500 index broke through the long-standing 200-day support level on March 9 and 10, and it wasn't until March 12, when the U.S. Treasury, the Federal Reserve, and the FDIC announced an emergency rescue plan (BTFP), that U.S. stocks returned to near the support line after opening on the 13th.

Federal Reserve and Other Institutions Team Up to Rescue Banks, Driving Safe-Haven Assets Like Gold and Bitcoin to Rise in Sync

In the face of liquidity pressure on small and medium banks, the Federal Reserve has indeed taken concrete actions to provide support. The following two charts show the usage rate of the central bank's discount window and the changes in the Federal Reserve's balance sheet. It can be seen that on March 15 of this year, the usage rate of the discount window even exceeded that during the 2008 financial crisis. Regarding the changes in the Federal Reserve's balance sheet, a simple arithmetic calculation can be made: since April of last year, the Federal Reserve has been reducing its balance sheet while raising interest rates, tightening liquidity in the market. Over the past 11 months, the assets have been reduced from a peak of $8.96 trillion to $8.33 trillion, a total reduction of $625.8 billion. However, in just two weeks from March 7 to 21, it quickly increased its assets by $391.5 billion. This means that more than half of the scale of the Federal Reserve's balance sheet contraction over the past year has been reversed in less than two weeks.

The newly released liquidity to alleviate the pressure on small and medium banks has naturally impacted the capital markets. After March 10, cryptocurrencies, gold, and the Nasdaq all responded positively to the newly released liquidity. Bitcoin quickly broke through the previous resistance level of $25,000, reaching a high of $28,937. During this period, Bitcoin has increasingly highlighted its attributes as a safe-haven asset, with its market capitalization share surpassing 43%, indicating a trend of capital flowing away from smaller cryptocurrencies.

Continued Hawkish Tone on Rate Hikes and Control of Bank Rescue Scope Lead to General Pullback in Risk Assets

Against the backdrop of widespread skepticism about the impact of rate hikes on financial stability, the Federal Reserve's FOMC meeting in March arrived. The probabilities regarding whether to raise rates changed significantly several times before the meeting. After the release of the February CPI, before the small and medium bank crisis emerged, the probability of a 50bp rate hike in interest rate swaps rose to over 70%; however, after the emergence of the small and medium bank crisis, the probabilities of a 25bp hike or no hike surged. At this point, it was a relatively difficult choice for the Federal Reserve. If only considering the CPI growth rate, it was likely to continue raising rates by 50bp, which would further tighten liquidity in the financial markets and could lead to more unexpected crisis events. If no rate hike occurred, it might lead the market to speculate whether there are larger undisclosed challenges to financial stability. Until March 22, the FOMC meeting decided to raise rates by 25bp, which was in line with market expectations. However, during the subsequent press conference, Chairman Powell's attitude caused market sentiment to reverse again. When Powell mentioned that the current liquidity issues of small and medium banks were leading to credit tightening, achieving some of the effects of rate hikes, the market still perceived it as dovish. However, Powell quickly emphasized that all voting members unanimously believed there was no need for rate cuts this year. Coupled with Treasury Secretary Yellen's almost simultaneous statement that the possibility of expanding deposit guarantees in the near term was low, U.S. stocks and Bitcoin fell in sync.

Market Outlook

Recently, from a technical perspective, the S&P 500 has tested the support of the 200-day moving average, showing a trend of gradually lower highs; from a news perspective, the capital market lacks new momentum. In the cryptocurrency market, the continuously disclosed regulatory news from the U.S. has also affected market sentiment, and the probability of short-term fluctuations or pullbacks remains significant, requiring more time and news coordination to confirm the direction.

Disclaimer

All content contained in this article is for reference only and does not constitute investment advice to any person. The sources of the information contained in this article are considered reliable, but there is no guarantee of its accuracy and completeness, nor that the information and advice contained will not change, and no responsibility is accepted for any direct or indirect loss arising from the use of the materials contained in this article or any related losses.