Yesterday, I wrote about how your cash is protected in the wake of Silicon Valley Bank’s (SVB) failure last week, and I promised to write about the potential impact on the overall economy today.

Before I do that, I thought I would let you know that one of the two primary corporate bond funds that we use owned some SCV bonds that lost about half of their value since last Thursday. The good news is that the fund is highly diversified, and actually made money during that time.

Although those bonds lost a lot of value, they were a very small part of the fund, less than 0.05 percent, by my estimation. And, since interest rates fell substantially, the rest of the bonds in the fund gained value, more than offsetting the loss on SVB. In an email, Ryan Craft remarked, ‘diversification for the win.’

Now, back to the discussion I promised: the macro view.

First, I should say that no one really knows what will happen next, and you can bet that policy makers are working around the clock to figure out what to do next. They’ve already put some strong policies into place beyond backstopping the uninsured depositors at the two failed banks.

But before we raise our hands in applause for those policy makers, we should also recognize that they are the same policy makers that created this situation. It’s often said that the Fed raises interest rates ‘until something breaks.’

Something broke alright.

The question now is whether the breakage is limited to a liquidity constrained California bank with a concentrated deposit base (and a crypto bank in New York) or something broader.

It depends a lot on what happens from here, but the wild change in the direction of the bond market is sending some signals. This year, the bond market has been hemming and hawing about how high interest rates might go, and how quickly they might get there.

One week ago, the bond market was pricing in a 100 percent chance of four more hikes by July with the Fed Funds rate reaching 5.6 percent.

Today, the bond market is calling for one more hike that would bring the Fed funds rate to 4.8 percent in May and then dramatically cutting rates thereafter. By the end of the year, the bond market is pricing in three cuts that would bring the Fed Funds rate to 3.9 percent, which would be in response to a recession.

The Federal Reserve was already in a difficult spot before SVBs failure because of their dual mandate: stable prices and maximum sustainable employment.

The Fed wanted to make sure that inflation was truly slayed and reduce the risk of a second wave of inflation, like what happened in early 1980s, which is why they said rates would likely stay high for some time.

To date, higher rates haven’t had a broad impact on the labor market. There are a lot of ways to cut the data, but the basic unemployment rate is 3.6 percent, which is lower than the 4.0 percent rate when the interest rate hikes began.

That gave the Fed some flexibility to be tough on inflation, but if there is a recession and the unemployment rate starts to rise amid a broader economic slowdown, the Fed doesn’t have the same flexibility because they would need to cut interest rates to promote growth (like what is being priced into the bond market now).

By the time this email goes out, things could be wildly different because the Bureau of Labor Statistics will have reported the February inflation numbers.

The expectations are for the headline rate to come in at 6.0 percent year-over-year, and 5.5 percent year-over-year for the core, ex food and energy rate.

As noted above, the Fed is in a difficult spot. They were before SVB, but it’s even more complicated now. As I’ve said many times before, I’m glad I’m not a Fed governor.

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Last week, I told you about an ETF that shorts the stocks that CNBC personality Jim Cramer picks (you can read the article here).

For what it’s worth, I heard Cramer on my commute home today apologizing for recommending Silicon Valley Bank in February. At the time, it was one of the ten best performing stocks on a year-to-date basis.