Popular macro strategist Lyn Alden is warning investors that the US banking system is sitting on hundreds of billions of dollars worth of unrealized losses.
In a fresh installment of the macro guru’s newsletter, Alden explains how the current banking crisis is different from the one witnessed in 2008 when the US housing and financial markets triggered a global recession.
According to Alden, banks today largely invested in US treasuries or bonds between 2020 and 2021 when the government introduced fiscal stimulus and the Fed kept interest rates low. These fixed-income securities are generally considered much safer than the subprime mortgages the banks held nearly two decades ago.
While Alden says government bonds are “nominally risk-free” if held to maturity, the macro expert points to the Federal Reserve’s aggressive interest rate hikes over the past year as the root cause of the current banking crisis.
“The Federal Reserve raised interest rates at the quickest absolute pace in decades (a 4.49% move in one year), and the quickest percentage pace of all time (from 0.08% to 4.57% in one year, or a 57x increase).”
According to Alden, the historical surge in interest rates has significantly decreased the value of treasuries held by US banks.
Treasuries tend to plummet in value when interest rates are soaring. Older bonds that were bought at a time when interest rates are low now have to compete with new treasuries that offer higher yields due to surging interest rates. As a result, sellers are left booking losses.
“After a year of rapid interest rate increases, the prices of those fixed-income securities are now lower than they were when banks bought them.
In other words, if they bought a 10-year Treasury note when yields were 1.5%, and today they are 4%, then those older Treasuries will be discounted in terms of price by about 15-20% by any potential buyers.
Due to buying so many securities when interest rates were low that are now heavily discounted if they were to be sold, banks have a lot of unrealized losses. Over $600 billion worth of unrealized losses, in fact.”
According to Alden, banks can sit on these losses and get all of their investments back if they hold the bonds to maturity. However, the current bank run is forcing institutions to sell these instruments at a heavy discount to meet depositor demand.
Last week, Silicon Valley Bank suffered a run and collapsed after it revealed $1.8 billion in losses, largely due to selling US bonds that lost much of their value.
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