The Banks, Rates, AI Releases

The Banks

Big questions remain following the collapse of Silicon Valley Bank. To start, who is to blame? It’s fair to say that both the Fed and SVB are responsible. The bank clearly mismanaged its risk in the face of rising rates. Social media and mobile apps also dramatically accelerate bank runs.

Bond performance doesn’t get the headline coverage it deserves. In the US the bond market is roughly twice the size of the equity market. I think it will surprise most people to learn just how bad the carnage has been in the bond market. Medium duration treasuries (7-10 years) are down between 20-25% from the highs of 2020. Longer duration treasuries (20+ years) are down 40-45% from the highs. This is a direct result of rate rises and it led to the collapse of at least one major bank.

Many have said “something will break” as a result of rate hikes. In October, UK pension funds faced a crisis related to their long duration bonds that required intervention. Credit Suisse is now reportedly in trouble as well. Broadly speaking “someone” owns all of those long duration bond assets, whether its banks like SVB, Credit Suisse or even Schwab to a much lower degree.

Long duration bond holders have massive mark-to-market losses that will go away as they are held to maturity. Even still, it’s hard to ignore the impact when an asset that was estimated to earn a paltry 1.25% per year drops in value by 20% to 40% just a year later. The impact of the bond losses is being felt, clearly, and it brings up the other big question: how will the Fed change its rate policy?

SVB wasn’t the only bank failure. Signature bank, one of the few that supports crypto was also mysteriously shut down. Many in the crypto world call it an open conspiracy against them. I don’t have an opinion but admit the optics are suspicious. There are now basically no banks left supporting the crypto ecosystem. Bitcoin has rallied dramatically since the SVB failure as its price is sensitive to increases anti-establishment sentiment, as well as any hints of “bailouts”.

Rates

Last week Powell successfully scared markets into thinking rates would continue to rise and stay higher for longer. The market believed him and priced in a 50 bp hike in March, which represented a re-acceleration of tightening policy. Whether or not Powell hikes 25 bps at all next week matters less. Rate cuts are now priced in starting as early as June.

CPI(inflation) came in this week at 6%, which is still higher than the 4.75% Fed interest rates. Everyone, including the Fed, would like to see inflation below the Fed funds before rate cuts start.

Truflation shows 4.3% for its real time inflation estimates. Oil is down -30% y/y. Gasoline is down -16% y/y and -42% since June 2022. Lumber is down -61% y/y. Steel is down -16% y/y. Many core commodities are down. Official inflation numbers are clearly lagging. There have even been hints at “excuseflation” or simply companies using “inflation” to raise prices even when their own costs hadn’t increased.

The biggest impact has been the drop in the 2-year treasury from 5% to below 4% and the drop in the 10-year from 4% to 3.4%. Dropping rates will have a big positive impact on equity prices if they hold.

AI Releases

Rapid Fire… OpenAI released GPT-4. Expect the cycle for AI releases to continue at warp speed. Our network says the AI coding assistants are hit and miss, but have provided real value and have built real products end-to-end that are currently in use. AI is valuable as an efficiency tool. If it can save time by filling in knowledge gaps or producing work at lower costs, that is a major win for everyone.

**Try out Shopify’s Shop page.** It aggregates all Shopify stores (which are all separately owned and managed) and allows you to search for purchases via a chatbot interface.

One of my all time favorite education institutions is Khan Academy which started 10 years ago with its excellent Youtube math lessons. **Khan Academy’s Khan Labs now has a waitlist for Khanmigo, an AI powered writing tutor.** Notably, the AI assistant helps guide in the learning process and effectively acting as a one-on-one tutor. Tutors are expensive but AI is not and inclusive education resources are beneficial to everyone, globally.