The recent turmoil in the banking industry has sparked concerns about a potential recession and has led to a significant drop in the stock market. The S&P 500 fell by 1.1% in morning trading, erasing its gains for the week, while the Dow Jones Industrial Average dropped by 1.3%, or 429 points, to 31,817. The Nasdaq composite also fell by 0.8%.
The banking industry has been at the center of this market volatility, with the second- and third-largest U.S. bank failures in history adding to investors' worries. Credit Suisse shares dropped nearly 8%, while First Republic Bank saw a 19.4% decline in its shares and was on track for a 66% drop for the week. These banks have different issues challenging them, but the overriding fear is that the banking system may be cracking under the weight of the fastest set of hikes to interest rates in decades.
Despite some analysts reassuring investors that the current chaos is nowhere near as bad as the 2007-08 financial crisis, the troubles still raise concerns about a recession. Problems for banks could mean problems for smaller and mid-sized companies getting the loans they need to grow. In fact, since 1870, there have been 14 big world recessions, all driven by wars, pandemics, and banking crises.
To address the stresses in the system, banks have borrowed nearly $165 billion from the Federal Reserve over the past week, highlighting the severity of the situation. After years of enjoying historically easy conditions, banks and the economy are now getting a shock to the system after the Federal Reserve and other central banks raised interest rates at a blistering pace to control high inflation.
While higher rates can help tame inflation, they also raise the risk of a recession later on and hurt prices for stocks, bonds, and other investments. The bond market has been particularly volatile, with yields swinging as traders drastically recalibrate bets for where the Fed will take rates. The yield on the two-year Treasury, which closely tracks expectations for the Fed, fell to 3.98% from 4.17% late Thursday, a massive move for the bond market.
To root out banks with similar traits to Silicon Valley Bank, Wall Street has been monitoring banks with lots of depositors with more than the $250,000 limit insured by the Federal Deposit Insurance Corp. or lots of tech startups and other highly connected people that can spread worries about a bank's strength quickly. As a result, Wall Street has been closely watching San Francisco-based First Republic Bank, which has received a vote of confidence from 11 of the biggest banks, who have pledged to deposit a combined $30 billion in the bank to show their confidence in it and banks in general.
The recent market volatility has also had a significant impact on consumer spending, which is at the heart of the US economy. Confidence has fallen, and easing expectations for the Fed have helped several Big Tech stocks lead the market this week. Although they have their own problems, these stocks tend to benefit from lower interest rates. As a result, the S&P 500 is still on track for a weekly gain of 1.5%. In contrast, cryptocurrencies have surged this week, with Bitcoin up more than 30%.
In conclusion, the recent market volatility underscores the fragility of the banking system and its potential to impact the broader economy. While the current situation may not be as dire as the 2007-08 financial crisis, it raises concerns about a potential recession. It also highlights the importance of monitoring the banking industry closely and taking measures to address any issues that may arise.