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What in the world happened last week?

Last week was marked by significant market turmoil that began with the collapse of a small bank in the United States, escalated into a panic about the global financial system, and culminated in a bold attempt to stem the cascading crisis that ultimately fell short.

This was the clearest illustration yet of the dangerous side effects of central banks’ campaigns to raise interest rates. In the year since the Federal Reserve began pushing rates higher, in an effort to stamp out runaway inflation, investors have watched shares of speculative tech companies crash, emerging markets fall into default, and the nascent cryptocurrency market crumple.

This week, the collapse of Silicon Valley Bank, a midsize bank that served start-ups and venture capital firms, incited chaos in the markets and prompted fears of a financial crisis.
Stocks swung wildly day to day, oil prices slid to lows not seen in over a year, and yields on government bonds suddenly reversed their march higher as investors began to wonder about the impact of the escalating crisis on the economy. The dust is yet to settle. Here’s a summary of what happened in markets this week, and what it tells us about investors’ views of the world going forward.

It all started with SVB

The trouble began on March 8, when Silicon Valley Bank revealed steep losses on its portfolio of government bonds and mortgages, ostensibly safe investments that backed the bank’s deposits and that had taken a hit from rising interest rates. The bank’s shares plunged, depositors rushed to pull out their money and, within days, authorities seized control of the bank (as well as Signature Bank, based in New York), pledging to keep it open for business.

But in the markets, investors couldn’t shake the worry that other banks were facing similar problems, and that induced a panic regarding a number of small lenders, including First Republic Bank, PacWest and Western Alliance. The wave of selling in their shares appeared to subside on Thursday, after a group of rival lenders said they would bolster First Republic with $30 billion in deposits. Then on Friday, selling resumed, and First Republic dropped a further 20 percent.

The selling has left shares of the banks’ sharply lower than they were before the collapse of Silicon Valley Bank. First Republic has lost over 80 per cent of its value since the start of the month, PacWest and Western Alliance roughly 60 per cent.

The good news for most investors is that the S&P 500 was resilient to worries that centred on the banking industry, and after a big rally on Thursday, the index ended the week with a gain of 1.4 per cent. It shows that, to stock investors at least, the crisis in the banking sector appears mostly contained. It helped that policymakers in the United States and Europe stepped in to back their banks. Authorities guaranteed deposits at SVB and Signature, and in Europe, Credit Suisse said it would tap a $54 billion lifeline from the Swiss National Bank after investors there began to panic over its financial state — though for very different reasons than with SVB.

Bond bombs

Perhaps the starkest evidence of a shifting view on the economy came in the market for government bonds. On Wednesday, the yield on two-year U.S. government notes, known as Treasuries, plummeted by a magnitude greater than Black Monday in October 1987, one of the worst market crashes on record.

The two-year yield is a barometer of changing expectations for interest rates, and it had been climbing fast as investors bet on further rate hikes from the Fed. In early March, the yield had crossed above 5 per cent for the first time since 2007. By Friday, the yield had tumbled to 3.85 per cent — a huge swing by the bond market’s standards. The signal from the markets was clear: The Fed is going to need to start cutting interest rates, or more failures are all but guaranteed.