I want all of you to succeed in whatever investing you do. So take 5 minutes to digest this.
Recently, banks like Signature and SVB were forced to liquidate their losing bond positions to pay back cash deposits. Even after liquidation, the banks did not have enough cash to pay out the deposits. FDIC insurance kicked in and the Feds responded because 90% of cash deposits were not insured (over 250k deposit.)
Before the bank failures. Short term treasuries were being offered at 5% and the markets were not interested. Now the bond market essentially received a bond buy back. The HTM securities are now all priced at 5% rates. Essentially the Fed just bailed out the bond market with a reset to par value. With so many bonds priced at 5%, it is hard for the Feds to continue to hike and 5% yields are very attractive. Essentially all grade A bonds held by banks (basically all bonds) are guaranteed by the Fed at par until the purchasing program ends. Are they going to continue to hike until more things break? Who knows?! But immunity is power.
Power Overwhelming; Cheat Enabled: Immunity Granted
I think it could be said to be hike proof and inflation proof since the yields don’t matter.
When these banks failed, the Feds also looked into paper losses at banks such as JPMorgan, etc. See below. 10-K that reflect December 31, 2022
Citigroup (C) loss per share ($16.02) 33% of stock price
AFS $256,608 million cost – $249,679 million fair value = $5,929 million loss
HTM $268,863 million cost – $243,648 million fair value = $25,215 million loss
*Total loss $31,144 million
JPMorgan Chase (JPM) loss per share ($16.00) 12% of stock price
AFS $216,217 million cost – $205,857 million fair value = $10,360 million loss
HTM $425,372 million cost – $388,648 million fair value = $36,724 million loss
*Total loss $47,084 million
Signature Bank (SBNY) loss per share $51.44 73% of stock price
AFS $21,071 million cost – $18,594 million fair value = $2,477 million loss
HTM $7,780 million cost – $7,018 million fair value = $762 million loss
*Total loss $3,239 million
U.S. Bancorp (USB) loss per share $12.68 31% of stock price
AFS $81,450 million cost – $72,910 million fair value = $8,540 million loss
HTM $88,740 million cost – $77,874 million fair value = $10,866 million loss
*Total loss $19,406 million
First Republic Bank (FRC) loss per share $28.15 34% of stock price
AFS $3,817 million cost – $3,347 million fair value = $470 million loss
HTM $28,359 million cost – $23,587 million fair value = $4,772 million loss
*Total loss $5,242 million
A majority of these securities are long term treasuries, and mortgage backed securities. (Remember when money was lent out cheaply in 2015, 2016, 2019, 2020, 2021?)
The 60/40 bond portfolio has failed. The stock market dropped 25% from it’s high to recent lows. The bond market on the other hand is down 10-15% average on low risk A grade bonds.
Bond Bailout:
www.federalreserve.gov/newsevents/pressreleases/files/monetary20230312a1.pdf‘
Bonds were impacted a lot due to inflation and interest rate hikes. Every-time inflation went up, bonds were worth less because the dollar strength deteriorated. Money borrowed is returned with money that is worth less. Every time the interest rates were hiked, old bonds become worth less as new bonds have higher yields. The bond market moves in tandem and pricing is all connected. New bonds issued, the old bonds are adjusted to worth less.
With the new bank term funding program. The Feds have created the great reset for the bond market. All old bonds held by banking institutions are valued by the Fed at par value. If the retail price was $1000, it is now worth $1000 provided it was used as collateral to borrow money from the Fed at 5% interest rate.
Why must banks collateralize the paper loss securities? Because it’s free money in the short term and saves their paper losses provided they borrow at current rates.
The math is simple to prove that this is beneficial.
Conditions:
$1000 paper loss on $10000.
Loan at 5% at par value.
The HTM security is worth $9000 present value. If you take a loan it is valued at $10000. Essentially a stop loss/hedge on the position and you net $1000 in profit. If the loan is held for 1 year. 5% interest on loan would be a $500. There is $10000 in cash flow for investments, loans, operating. If the loan is not taken, it’s a $1000 paper loss and $9000 that is illiquid until maturity unless sold at a loss.
What this means is that all paper losses have been wiped out by the Fed and the bond market is now priced as if there was no interest hikes and 2% inflation. When there is no interest hike and 2% inflation, it was very difficult to get 2% interest payments.
Again: Before the bank failures. Short term treasuries were being offered at 5% and the markets were not interested. Now the bond market essentially received a bond buy back. The HTM securities are now all priced at 5% rates. Essentially the Fed just bailed out the bond market with a reset in interest rates. With so many bonds priced at 5%, it is hard for the Feds to continue to hike and even if they do hike, bonds are granted immunity*
Notes from me:
I can imagine the 60/40 portfolio becoming very popular again or even 50/50 as investors and fund managers adjust the portfolios. I think a majority of portfolios are hedged but not at the current 60/40 ratio. I also think the stock market will crash when the fed fund rate comes to a halt in increases.
See figure below when the Fed funds rate halted and plateued, the stock market crashed some time after. I think profit taking is always a smart choice in conditions like this. I would add to winners when all conditions are favorable, booming times. I think it is smart to start hedging into bonds, potentially SPTS and brace for when markets go into turmoil. Remember, don’t buy the dip, buy from dips.
Disclaimer: This information is only for educational purposes. Do not make any investment decisions based on the information in this article. Do you own due diligence or consult your financial professional before making any investment decision.