The banking crisis reminds us how much financial institutions and markets are driven by psychology.
A bank may be perfectly solvent one minute and collapse from a bank run the next. A stock may skyrocket one day on news it got billions from a cash infusion, and crater the next even though nothing material has changed in the intervening period.
These are general sketches — depositors did have reasonable concerns about Silicon Valley Bank's losses, for example — but the general principle holds. In other words, a bank's stock — or that of any other company — may not necessarily reflect the health of its balance sheet, even though a correlation may seem apparent.
Markets in the U.S. and Europe demonstrated this principle Friday. Despite rebounding on Thursday amid news of financial support by central banks and financial regulators, on Friday, banks were badly hammered — once again — and dragged down major indexes with them. The Dow Jones Industrial Average fell 1.19%, the S&P 500 lost 1.10% and the Nasdaq Composite slid 0.74%. This suggests investors aren't convinced that banks — and the broader economy — can be made whole with the current measures.
Whether the Federal Reserve shares investors' mindset is another matter. Fed officials say they rely on data to determine the trajectory of interest rates. Going by the current turmoil in the banking sector, Mark Zandi, chief economist at Moody's Analytics, thinks it's wiser for the Fed to pause rate hikes.
But data isn't the only factor the Fed is thinking about; the psychology of investors comes into play as well. As Doug Roberts, founder and chief investment strategist at Channel Capital Research, said, Fed officials have "to do something, otherwise they lose credibility." And credibility seems like the one resource banks sorely lacked last week, and which markets need going ahead.
