Regional Banks, Possible Recession, and Debt Ceiling Explored

Have questions about the current market environment? John Zaller, CIO, MAI Capital, is here to answer them. From regional banks to recession, John responds to a few of the most commonly asked questions from MAI clients.

1. Will the stress in the regional banks lead to another financial crisis, similar to what we experienced in 2008?

While the recent bank failures echo the Great Financial Crisis, our team at MAI thinks this episode is different for a few reasons.

• Thanks to increased regulatory scrutiny, the banking system at-large is on more solid footing than in 2008 because the largest banks are now required to maintain higher capital ratios and undergo regular stress tests.
• Top-tier banks have been acting like safe havens this year rather than the crisis epicenter like they were in 2008.
• Regional bank failures are still impactful, but the concern today is a pullback in regional bank lending that slows the economy rather than a system meltdown.
• The balance sheet issues facing regional banks are tied to well-understood interest rate impacts rather than unknown credit impacts (like the mortgage crisis in 2008).
• Rising interest rates have caused market-to-market losses in bond portfolios on bank balance sheets, but are easily quantifiable, and losses are transparent and manageable for most banks.

The path forward for regional banks largely depends on investor and depositor confidence outweighing fear. In the past month, deposits at US commercial banks have stabilized (as shown in the chart below from the Federal Reserve). Recent data specific to regional bank deposits has also shown deposits stabilizing despite continued pressure on stock and bond prices. At MAI, we will be watching closely to better gauge the impact of the current bank turmoil on the economy.

as of date 4/26/23

2. What will happen if Congress does not raise the debt ceiling in time?

Unfortunately, the debt ceiling has once again become an opportunity for political brinkmanship, and there is a risk that Congress will underestimate the potential damage of failing to compromise.

Fortunately, we believe that cooler heads will prevail, and a deal will occur prior to time running out.

If today’s level of political polarization prevents a favorable scenario, we still want to recognize that it does not automatically lead to a US default on its debts. In fact, our team at MAI thinks the risk of a default is extremely low for the following reasons:

• The Treasury has prioritized payments of principal and interest relative to other allocations.
• The Treasury would most likely delay funding for other government programs, which is not ideal for economic growth, but could prevent a US default.

The larger issue that will have longer-lasting implications for economic growth and interest rates is the fact that interest costs as a percentage of the federal budget are about to surge to levels not seen in the past few decades. 

3. You’ve been discussing the probability of a recession occurring for the past six months or so, but I have only seen minor adjustments in my portfolio. Why is that?

This is a terrific question, and our answer is this: a portfolio underpinned by a long-term strategic plan should not be significantly altered based on an economic or market forecast. Decades of experience have made it clear that forecasts are subject to change and that short-term performance is impossible to predict with any consistency.

Instead of trying to time the market, our approach at MAI is to make tactical adjustments that align with our views, but won’t materially depart from the long-term allocation that supports our clients’ financial plans. For example, today this may include holding more cash at the margin given the favorable interest rate environment on the short end, using structured notes to provide extra downside protection, or using alternatives to diversify stock and bond exposures. 

In every case, we remain focused on constructing a portfolio that we believe can deliver on your unique set of goals and objectives as long as we stay the course through the ups and downs of the markets. 

If you have any questions related to this topic or your portfolio in general, please do not hesitate to reach out to your wealth advisor at any time.

Please send your questions, comments, and feedback to: info@mai.capital. Any statement non-factual in nature constitutes only current opinion of this author which is subject to change without notice. Certain statements are of future expectations and other forward-looking statements are based on management’s current views and assumptions. Any statistics mentioned have been obtained from sources we believe to be reliable, but the accuracy and completeness of the information cannot be guaranteed. Neither the information nor any views expressed should be considered investment, legal or tax advice, or constitute as a recommendation to buy or sell any security, strategy, or product. It should not be assumed that this is a forecast of future events or that any security transactions, holding, or sector discussed where or will be profitable or that the investment recommendations or decisions we make in the future will be profitable. Past performance is not indicative of future results.