• Products
  • Insights
  • Practice Management
  • Resources
  • About Us

In a matter of days, the cumulative effect of US Federal Reserve (Fed) policy tightening has hit the US banking sector hard, beginning with the collapse of Silicon Valley Bank (SVB) on March 10.

Panicked depositors in several banks have since rushed to the exits, setting off a liquidity crisis and leaving some banks’ capital positions in precarious shape. The Fed and the US Treasury have taken swift steps to help stabilize the banking system by providing liquidity and assuring impacted depositors that they will be made whole. This past weekend, they unveiled several new facilities designed to ease the liquidity crunch and to prevent further bank runs.

However, growing investor concerns are sweeping financial markets. While safe-haven assets have benefited, Fed rate-hike expectations have been all but extinguished, government bond yields are lower and credit spreads1 wider, and the US dollar (USD) has strengthened. Meanwhile, global equities are down, and small-cap stocks are the biggest laggards so far.

The situation is evolving rapidly, as are the potential economic and market implications. Here are some key points from Wellington’s latest discussions, highlighted by a common theme that there’s now a greater probability of a US recession in the near term. Many of us also think investors should consider pivoting to a risk-management mode that favors higher-quality assets.

  • A liquidity crunch is what got us here: The fragile liquidity conditions that started as a bank run on SVB have spread to other regional US banks, especially those most dependent on customer deposits. The dynamic basically involves a mismatch between a bank’s assets and its liabilities: Depositors demand their money back (short-term liabilities), forcing the bank to sell securities from its investment portfolio (long-term assets) at large losses (due to the 300 basis-point2 (bps) spike in interest rates over the past two years).
  • Liquidity issues can turn into capital issues: Large unrealized losses in some banks’ securities portfolios could be a more widespread problem. These losses have fed into the banks’ concerns around having sufficient capital to continue operating normally. Therefore, I expect robust capital-raising efforts to be undertaken as a next step toward fortifying the US banking industry. Considering the size of banks’ portfolios and the likely losses caused by rising rates, I estimate that a manageable $50-$100 billion of capital will be needed.
  • Many banks’ net-interest margins and profitability may be pinched: Banks’ cost of doing business will rise in the period ahead, due to increasingly tighter financial conditions and as a direct result of the banks having to raise their customers’ deposit rates. Therefore, I suspect that many banks’ net-interest margins will inevitably narrow, as will their profitability in all likelihood. This could be a particularly troublesome issue for the continued viability of smaller, more vulnerable banks that generally have only regional access to customer deposits.
  • There may be spillover to broader credit conditions: Since the banking system is at the heart of credit transmission, the challenges facing many banks are likely to have spillover effects, including creating even tighter lending conditions (which had already tightened meaningfully with the Fed’s rate-hiking campaign). A tighter lending environment, in turn, could impact the volume of lending that actually takes place. This is a cyclical risk that could impair the US economy and further increases the odds of a recession.
  • The Fed is likely to respond as needed: Tighter credit conditions tend to be disinflationary, leaving the Fed room to ease up on the size and pace of its rate hikes. I’m reasonably confident that the Fed will prioritize stimulating growth over fighting inflation if the current banking crisis risks destabilizing the financial system. Markets are currently pricing in one 25-bps rate hike, followed by nearly 75 bps of policy easing by year end. However, markets may be disappointed if liquidity-generating measures can contain the damage from recent events.
  • What about the rest of the world? There are clearly different dynamics at play from one global region to another. For example, China’s economy seems fairly well-insulated from current US woes, with its economy (and other Asian economies) benefiting from its recent reopening. Europe and Japan may also improve relative to the US, especially if the USD loses some of its luster and the Fed becomes less hawkish. These outcomes will depend, importantly, on whether US liquidity worsens further and restrains global growth.


Final Thoughts

The speed and magnitude of the Fed’s about-face from easy to tight monetary policy was bound to expose firms caught on the wrong side of rising rates. That’s precisely what’s happening here, and with the broader financial system now caught up in the turmoil, systemic risks should not be taken lightly. However, the US banking system is generally strong, especially the large, well-capitalized banks, and US regulation is designed to deal with commercial bank failures. I believe the Fed and Treasury will respond decisively to avoid a worst-case outcome.


My Base Case and Investment Implications

In the near term, I think risk-off dynamics could dominate and less-risky assets could outperform. Financials and other sectors tied to the economic cycle could struggle the most. I also expect large-cap stocks to outperform smaller-cap stocks and growth-style equities to outperform value in the short term. China and other Asian markets tied to China’s recovery are apt to outperform the US and Europe, in my view.

Longer term, I see investment opportunities. Notably, I think quality assets may still be rewarded over time—for example, large money-center banks that have ample capital and have been subject to stricter regulation than smaller banks. In addition, some high-quality US fixed-income assets may offer relatively attractive yields and total-return potential if the economy softens. In terms of risks, if the Fed’s additional liquidity succeeds in averting a full-blown financial crisis but fans the flames of inflation, the Fed may need further rate hikes down the line. This is another reason I suggest favoring quality.

Bottom line: Until this all subsides, proceed cautiously, and be prepared to consider the “higher for longer” investment playbook for inflation and rates in your long game.

Talk to your financial professional about how you can help position your portfolio for potential market volatility.



1 Spreads are the difference in yields between two fixed-income securities with the same maturity, but originating from different investment sectors.

2 A basis point is a unit that is equal to 1/100th of 1% and is used to denote the change in a financial instrument. The basis point is commonly used for calculating changes in interest rates, equity indices and the yield of a fixed-income security.

Important Risks: Investing involves risk, including the possible loss of principal. • Fixed income security risks include credit, liquidity, call, duration, and interest-rate risk. As interest rates rise, bond prices generally fall. • Small-cap securities can have greater risks and volatility than large-cap securities. • Foreign investments may be more volatile and less liquid than US investments and are subject to the risk of currency fluctuations and adverse political, economic and regulatory developments. These risks may be greater, and include additional risks, for investments in emerging markets. • Investments focused in specific sectors may be subject to increased volatility and risk of loss if adverse developments occur. • Different investment styles may go in and out of favor, which may cause an investment to underperform the broader stock market.

The views expressed here are those of Nanette Abuhoff Jacobson and Wellington Management’s Investment Strategy Team. They should not be construed as investment advice. They are based on available information and are subject to change without notice. Portfolio positioning is at the discretion of the individual portfolio management teams; individual portfolio management teams and different fund sub-advisers may hold different views, and may make different investment decisions for different clients or portfolios. This material and/or its contents are current as of the time of writing and may not be reproduced or distributed in whole or in part, for any purpose, without the express written consent of Wellington Management or Hartford Funds.

MFGS_031423 2791898

About The Authors
Nanette Abuhoff Jacobson Headshot
Managing Director and Multi-Asset Strategist at Wellington Management Company and Global Investment Strategist for Hartford Funds

Nanette Abuhoff Jacobson consults with clients on strategic asset allocation issues and works with investment teams throughout Wellington to develop relevant investment solutions across asset classes.

Advisor Webcast

2Q Outlook: Putting the Global Economy to the Test

The material on this site is for informational and educational purposes only. The material should not be considered tax or legal advice and is not to be relied on as a forecast. The material is also not a recommendation or advice regarding any particular security, strategy or product. Hartford Funds does not represent that any products or strategies discussed are appropriate for any particular investor so investors should seek their own professional advice before investing. Hartford Funds does not serve as a fiduciary. Content is current as of the publication date or date indicated, and may be superseded by subsequent market and economic conditions.

Investing involves risk, including the possible loss of principal. Investors should carefully consider a fund's investment objectives, risks, charges and expenses. This and other important information is contained in the mutual fund, or ETF summary prospectus and/or prospectus, which can be obtained from a financial professional and should be read carefully before investing.

Mutual funds are distributed by Hartford Funds Distributors, LLC (HFD), Member FINRA|SIPC. ETFs are distributed by ALPS Distributors, Inc. (ALPS). Advisory services may be provided by Hartford Funds Management Company, LLC (HFMC) or its wholly owned subsidiary, Lattice Strategies LLC (Lattice). Certain funds are sub-advised by Wellington Management Company LLP and/or Schroder Investment Management North America Inc (SIMNA). Schroder Investment Management North America Ltd. (SIMNA Ltd) serves as a secondary sub-adviser to certain funds. HFMC, Lattice, Wellington Management, SIMNA, and SIMNA Ltd. are all SEC registered investment advisers. Hartford Funds refers to HFD, Lattice, and HFMC, which are not affiliated with any sub-adviser or ALPS. The funds and other products referred to on this Site may be offered and sold only to persons in the United States and its territories.

© Copyright 2023 Hartford Funds Management Group, Inc. All Rights Reserved. Not FDIC Insured | No Bank Guarantee | May Lose Value