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What do the markets say about the world?

by SuperiorInvest

It’s been a week of market turmoil that began with the failure of a small bank in the United States, escalated into panic about the global financial system, and ended with a bold effort to stop a cascading crisis.

And it was the clearest illustration yet of the dangerous side effects of central banks’ interest rate hike campaigns.

In a year when the Federal Reserve began pushing rates higher in an effort to curb rampant inflation, investors watched shares of speculative technology companies fall, emerging markets default and the emerging cryptocurrency market crumble.

This week it was the collapse of Silicon Valley Bank, a mid-sized bank that primarily served startups and venture capital firms, that sent markets into turmoil and raised fears of a financial crisis.

Stocks fluctuated wildly on a day-to-day basis, oil prices fell to lows not seen in more than a year and government bond yields suddenly reversed course higher as investors became concerned about the impact of the escalating crisis on the economy.

As the dust begins to settle, here’s a roundup of what happened in the markets this week and what it tells us about investors’ views of the world.

The trouble began on March 8, when Silicon Valley Bank revealed steep losses in its portfolio of government bonds and mortgages, the seemingly safe investments that backed the bank’s deposits, which have been hit by rising interest rates. The bank’s stock plunged, depositors rushed to withdraw their money, and within days the authorities took control of the bank (as well as New York-based Signature Bank) and pledged to keep it open for business.

But in the markets, investors couldn’t shake fears that other banks were facing similar problems, sparking panic among a number of small lenders, including First Republic Bank, PacWest and Western Alliance. The sell-off in their shares appeared to have ended only on Thursday after a group of rival lenders said they would bolster First Republic with $30 billion in deposits.

But even after the recovery, the stock prices of most of these banks remain well below where they were before the collapse of Silicon Valley Bank. First Republic has lost more than 70 percent of its value since the beginning of the month, while PacWest and Western Alliance are down more than 50 percent.

The good news for most investors is that the S&P 500 was resilient against concerns centered on the banking industry, and after Thursday’s big rally, the index was actually on track to end the week up around 2.5 percent. If true, it would be the index’s second-best week of the year.

It shows that, at least for stock investors, the crisis in the banking sector seems mostly closed. It helped that politicians in the United States and Europe supported their banks. Authorities have guaranteed deposits at SVB and Signature, and in Europe Credit Suisse said it would tap a $54 billion lifeline from the Swiss National Bank after investors there began to panic about its financial health — though for very different reasons than SVB.

Perhaps the most striking evidence of a shift in the outlook on the economy was the government bond market. On Wednesday, the yield on two-year US government bonds, known as Treasuries, fell by a value not seen since Black Monday in October 1987, one of the worst market declines in history.

The two-year yield is a barometer of changing interest rate expectations and rose quickly as investors bet on more rate hikes from the Fed.

In early March, the yield rose above 5 percent for the first time since 2007. By late Thursday, the yield had fallen to just 4.14 percent, a huge swing by bond market standards.

The signal from the markets was clear: The Fed would have to start cutting interest rates, rather than raising them, sooner than previously thought — something it usually only does when the economy runs into trouble.

Investors are not only worried about the US economy. A drop in commodity prices this week shows they are also worried about the global economy.

Oil prices are an example of this. After suffering its second steepest decline of the year on Wednesday, a barrel of West Texas Intermediate crude is now near its lowest price since late 2021.

Demand for oil is global, making it a barometer of the health of the world economy. It often fluctuates with economic news from other parts of the world. When things are booming, demand for oil is high and oil prices usually rise. Such a sharp decline is a warning that investors fear a drop in demand if the economy falters.

For now, a semblance of stability has returned, but investors remain on the hook for further damage.

Asked about the potential risks, some analysts point to other corners of the market prone to high interest rates, such as the corporate debt market, which swelled after the 2008 financial crisis. The pain in the banking sector could also prompt lenders to pull back on new business, tightening access to a vital source of cash if companies start to run into trouble – constraints that could weigh on growth.

And of course, the big fear for investors is usually that something hasn’t been revealed yet, like the trouble at a Silicon Valley regional bank more than a week ago.

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