Markets are priced for 100% bailout. Anything less than that and they will spontaneously explode...
Allow me to recap the past month:
Four weeks ago, Powell announced that the Fed was re-accelerating their rate hikes. By the end of that same week, the U.S. had suffered the second (Silicon Valley Bank) and third (Signature Bank) largest bank failures in U.S. history.
Subsequently, the Fed implemented their "BTFP" asset repurchase program whereby banks temporarily trade their unrealized loss encumbered assets in exchange for fresh Fed loans at 4.75%. Unfortunately, the average long bond exchanged in these programs is bearing 1.75% so the BTFP program allows banks to go out of business slowly, instead of instantaneously if they marked to market.
Meanwhile, Congress held a hearing into the collapse of these banks and thoroughly castigated the FDIC for bailing out wealthy depositors using the "Systemic Risk Exception" (SRE). Which is moronic because the entire catalyst for the bank run was wealthy depositors assuming that they can't rely upon the SRE for future bailout. Congress has now conveniently confirmed that assumption.
Therefore, imagine if you will that next some smaller banks implode and the FDIC decides NOT to implement the SRE and instead allows wealthy depositors to get wiped out. When that happens, we will witness mass bank failure as ~$8 trillion of uninsured deposits flees small banks and heads for money market and t-bill funds.
It's the same set of events that led up to Lehman. There had been multiple failures and multiple bailouts followed by a bailout-weary Fed finally deciding that Lehman was NOT too big to fail. So markets exploded. Because they were priced for 100% bailout.
All of which explains why after four weeks of BFTP, the small banks are at new lows. We are one non-bailout away from wholesale meltdown. So what to do?
Load up on risk.
"March recorded the worst U.S. bank failures since the 2008 crisis, but that did not stop some investors from snapping up battered financial stocks"
The other development over the past four weeks since Silicon Valley Bank exploded, is that the economy has fallen off a cliff.
Why? Because banks have tightened lending standards due to the new tighter regulatory and funding environment. Which means that the IPO equity market AND the bank lending market are both shutdown at the end of the cycle.
All of which means that the end of cycle stock to bond rotation has now begun. The exact same pundits who didn't predict the bank run, also did not predict the resulting slowdown in the economy. Which is why t-bond shorts are now getting duly monkey hammered.
Recession is a lock for 2023. And now even the majority of pundits who've been saying it wouldn't happen are finally realizing they were wrong. All because they thought that Fed tightening at the fastest rate in 40 years wouldn't lead to a tightening of credit:
“We have argued for some time that the economy would avoid recession this year," said Ian Shepherdson, chief economist and Kiernan Clancy, senior U.S. economist at Pantheon Macroeconomics. "But that view now looks untenable, given our expectation of a sharp tightening of credit"
The last market narrative that is now imploding is that Tech stocks are safe havens from deflation. During regular slow-growth part of the cycle that is certainly true. However, during the end of the cycle deep recession phase, that is false.
Below, fittingly we see that semiconductors are imploding on the right shoulder amid the highest volume since March 2021 aka. the left shoulder. Consider that volume is already the highest in two years and it's only Wednesday in a holiday shortened week.
In summary, the systemic risk explosion has been slowly coalescing for two years. However, this society has an extreme case of survivor bias and is highly adept at ignoring those who are already under the bus.
