The Silicon Valley Bank (#svb ) bailout today may or may not have prevented a bigger credit crisis, but it is a significant event that can provide investors with valuable insights into what lies ahead.

After almost two decades of loose monetary policies, the pandemic’s response led to the #inflation genie being released from the bottle. Despite denying it for nearly a year, the #federalreserve had to act to prevent prices from soaring, leading to the quickest tightening cycle in history, with rates jumping from 0.2% to 5% in twelve months. This had a devastating effect on #bond prices, as the majority of the $153 trillion asset class globally was issued at far lower rates. These losses are generally realized when the holder has to sell the security to fulfill withdrawals or other liquidity requirements. Consequently, almost every financial institution is sitting on significant unrealised losses in their bond portfolios, with banks or pension funds inevitably facing crises in case withdrawals were to accelerate (see chart for 4 largest US banks).

The central issue for the Fed and other central banks is whether to stop tightening, or even ease, to prevent further pain for financial institutions, or to continue the fight against inflation. The decision to backstop SVB’s depositors with an ad hoc lending facility may suggest the Fed’s commitment to taming inflation while, at the same time, providing reassurance to investors. This illusion is unlikely to last, as the SVB solution effectively equates to a backstop for bond portfolio losses and the willingness to add unlimited liquidity to the system, which is highly inflationary.

Investors can infer that the Fed will do everything in its power to avoid any systemic disruptions but that can only be achieved by accepting a higher level of inflation. This will continue until a significant amount of debt has been destroyed in real terms, and the system can be reset. Not a surprising outcome, as history shows that beyond a certain debt threshold, the only way forward is through currency debasement.

It is logical to expect more losses ahead first and foremost in rates sensitive sectors such as fixed income, private equity and long duration stocks. Conversely, stores of value and commodities should continue to benefit in what is essentially a stagflationary regime.

Disclosure: Not investment advice. Do your own research. Hold all assets mentioned. Twitter @pietroventani for more timely comments and updates

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