The Fed’s regime of higher rates is dialing up the pressure, especially on smaller regional banks that tend to be less diversified. For months, once high-flying parts of the market that relied on easy money, like crypto, venture capital and start-ups, and commercial real estate, have been under the hammer. Now, that weakness is reverberating through the banks most exposed to them.

Silicon Valley Bank, lender to tech start-ups and other VCs, saw its worst day ever as it announced its clients were withdrawing deposits. This prompted the bank to sell hoards of securities at a loss to improve its liquidity. And as of today, the FDIC has taken over receivership. Meanwhile, crypto-focused bank Silvergate Capital said it’s shutting down after weeks of turmoil (in large part due to outsized exposure to beleaguered FTX). And Cleveland-based Keycorp said it anticipates less net interest income as it faces tougher competition to offer attractive deposit rates.

Here’s the problem: With interest rates higher, banks are under pressure to up the ante on deposits (i.e., pay more) to keep savers in the door—if they can’t hack it, they risk their customers going elsewhere. Similarly, if times turn hard, clients might start burning through their cash too quickly, wearing down banks’ deposit base. In turn, panic about a downturn might also prompt others to yank their deposits, risking a bank run. That puts pressure on banks’ balance sheets, as securities invested when rates were low may need to be sold at a loss in order to buffer liquidity. Adding fuel to fire, the higher rates go, the less likely businesses and consumers are to make new loans (and generate new business for banks).

All that said, the pain has been mostly felt by smaller regional banks given their deposit bases have been quicker to flight, and their balance sheets tend to be riskier relative to larger banks.

Here’s the good news: Many of the larger, money center banks are far more diversified, more regulated and have fortress balance sheets – and thus aren’t feeling these stresses as acutely. This has left the banking sector as a whole much better capitalized today than it was during the Global Financial Crisis.

But, this does underscore the impact that tighter policy can have. As interest rates rise, it becomes more difficult to borrow, invest and spend. The Fed’s next move is in acute focus, which stresses the importance of today’s U.S. jobs report (and next week’s CPI print). This brings us to the following point.

2) The Fed may keep rates higher for longer—but it all depends on just how strong the economy stays.

At his testimony on Capitol Hill this week, Chair Powell doubled down on the Fed’s commitment to cooling inflation, signaling that central bankers could take policy rates higher still and ramp up the pace of hikes—but it all depends on the data. On one hand, growth is still strong, and inflation is still sticky, which could prompt a 50bps move at this month’s meeting (following their step down to 25bps in the last few meetings). But on the other, there were promising signs in today’s jobs report that suggest upping the pace might not be needed after all.

Today’s jobs report showed that the U.S. economy added another 311,000 jobs (following January’s blockbuster 504,000), in a sign that the economy is still strong. But, the Fed did get a few encouraging signs that it’s getting closer to getting its job done—the unemployment rate rose from 3.6% (from 3.4%) and wage growth was cooler than expected (at 4.6% year-over-year). While still a mixed reading overall, it may go to take some of the edge off.

The jury is still out on the Fed’s next move at its March meeting, but the more it has to hike, the greater the potential hit to the economy—and the greater the risk of recession.

Where to go from here:

So far this year, markets have quickly flitted between soft, no, and hard landing. Late cycle comes with transitions, and defensive positioning and diversification have historically been a good defense.

Bonds can provide crucial protection. The swift move lower in yields yesterday reminds us of the shield bonds can provide as the growth outlook worsens. We continue to focus on high quality, investment grade credit. And while banks overall make up roughly 25% of the U.S. investment grade market, regional domestic banks account for just 1.5% of the universe.

Further, this is why we’ve been focused on parts of the equity market that are more defensive in nature, backed by more secular growth, and/or that can offer better relative value—for instance, healthcare and industrials rather than financials in the U.S., as well as Europe and China. Strategies like structured notes can also offer downside protection and help to protect gains.

Above all, stick with your investment plan. While markets can always have a bad day, week, month, or even year, history suggests investors are less likely to suffer losses over longer periods – especially in a diversified portfolio.