(Bloomberg) – Stocks rose as regulators around the world rushed to boost market confidence, with the recent financial turmoil spurring speculation of a slower pace of tightening by major central banks.
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As earlier flight bids eased, financial stocks led gains in the S&P 500, and giants like JPMorgan Chase & Co. and Bank of America Corp. lifted a benchmark for US lenders by about 1.5%. First Republic Bank plunged after another credit rating downgrade, missing out on a rally by its regional peers led by New York Community Bancorp. UBS Group AG jumped as investors turned on the positive side of its acquisition by Credit Suisse Group AG.
Big tech companies — seen by many investors as a safer option in times of stress — underperformed on Monday after the Nasdaq 100 posted its biggest weekly gain since November. The rebound in risk appetite also sent Treasuries and the dollar lower.
Just a few weeks ago, investors were betting that the US Federal Reserve would hike rates to almost 6% and the European Central Bank to over 4%. Now markets are implying tightening cycles are almost over and betting at least four US rate cuts by year-end. Indexed overnight swaps this week are pricing in a 70% chance of a quarter-point hike by the Fed — a move that was thought to be a given before the banking crisis hit.
Swap traders currently expect the Fed benchmark to end the year around 4%, a full percentage point below the central bank’s rate estimate in the December “dot plot” that is part of the quarterly economic forecasts. In line with the theme of instilling confidence in the banking system, Fed Chair Jerome Powell may reiterate that further progress is needed towards the goal of price stability, according to BMO Capital Markets’ Ian Lyngen. A “pigeon-like hike” remains our bias, he added.
The story goes on
“We expect a 25 basis point rise and higher points on the scatter chart,” said Chris Low, chief economist at FHN Financial. “50 basis points would be reckless, but no hike would suggest that the banking crisis is crowding out the fight against inflation. 25 bp seems spot on given the circumstances. Of course, our view of Midtown Manhattan may not be quite the same as the Fed’s from Central DC, as they’re eyeing the internals of the banking system that we can’t see from here. If the Fed decides not to hike rates, the language they use to frame that decision will be key to shaping the entire yield curve.”
According to Brown Brothers Harriman’s Win Thin, market easing expectations have “gone haywire” because the media blackout has held back Fedspeak. Although no one knows to what extent the market turmoil is affecting the rate hike debate, Fed officials are likely to join ECB President Christine Lagarde in stressing last week that there is no trade-off between price and financial stability.
“This was a very strong statement, suggesting that problems in the banking sector are not derailing the tightening cycle,” he noted. “We believe that view is held by pretty much every central bank, including the Fed, which supports our call for a 25 basis point hike this week.
‘Malicious’
Morgan Stanley’s Michael Wilson said the stress in the banking system likely marks the beginning of a painful and “vicious” end to the bear market in US stocks.
“With the Fed/FDIC backlog of bank deposits, many equity investors are wondering if this is another form of QE and are therefore taking the risk,” the strategist wrote, marking the end of the bear market as falling credit availability stifled growth from the economy squeezes.”
In a matter of days, a banking crisis has ensued, potentially suffocating a hot economy and increasing the likelihood of a recession that the Fed has been working to avoid. As Fed Chair Jerome Powell and his colleagues gather for a two-day policy meeting on Tuesday, the question is whether the brakes have suddenly been pushed too hard. The central bank wanted a slowdown – something seen as essential to taming inflation – but not a crisis that could plunge the economy into a deep recession.
“As a result, a 25 basis point hike is the most likely outcome at next week’s FOMC meeting,” said Principal Asset Management’s Seema Shah. “If the market turmoil intensifies in the coming days, even a pause is possible. “Ultimately, financial conditions will continue to tighten – either through additional tightening from central banks trying to tame inflation, or through a worsening of the current banking crisis.”
In what is likely to be a volatile period, look for quality defensive assets while diversification becomes more important, Shah added.
Truist Wealth’s Keith Lerner says he also prefers to remain defensively positioned, even though the market appears to be quite resilient.
“While a pause or pivot in the Fed could trigger a near-term rally, we don’t see it as a panacea, especially if the economy goes into recession later this year,” added Lerner. “The Fed’s current events reaction function is likely to be less aggressive in providing monetary support compared to previous periods given the conundrum of still elevated inflation.”
$8.6 trillion
The turmoil in the banking sector combined with an earlier increase in funding pressures has left financial markets keen on what the Fed will say about its $8.6 trillion balance sheet.
Up until this month, it had contracted as part of the Fed’s effort to bring it back to pre-pandemic levels. But now it has started to expand again as the Fed acts to bolster the banking system through a series of emergency lending programs. Its latest move came Sunday as it worked with other central banks to increase US dollar liquidity. Some say financial stability concerns could spur policymakers to roll back their bond portfolio outflows, a process known as quantitative tightening, which aims to drain reserves from the system.
The failure of three domestic lenders and a spreading banking crisis in Europe have warped but not stalled the US stock market — until now. Beneath the surface, the firms with the most shaky finances lag their most solid competitors by an order of magnitude that has only been seen a few times before.
The division of the Russell 1000 Index into four baskets based on the level of debt versus market capitalization shows how large the gap has become. The basket of companies with the heaviest credit burdens fell 3% last week, 4.8 percentage points behind a basket with the healthiest financials. Since 2008, the gap has only been wider on two occasions — the peak of the pandemic in March 2020 and the week Lehman Brothers went under in September 2008.
Turmoil in the banking sector, hotter-than-expected inflation data, and renewed hopes for a dovish Federal Reserve have seen bitcoin hit levels not seen in about nine months. The largest digital coin surpassed $28,000 for the first time since June. Bitcoin is up more than 70% year-to-date. Other tokens have also rallied, with Ether up nearly 50% since Dec. 31 and Solana, one of the most down-performing coins of the past year, more than doubled.
Read: Investors see US economy strong as banking risks grow: MLIV Pulse
Important events this week:
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US Existing Home Sales, Tuesday
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US Treasury Secretary Janet Yellen appears at the Senate subcommittee hearing on Wednesday
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FOMC interest rate decision, Chairman Jerome Powell’s press briefing, Wednesday
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EIA crude oil inventory report, Wednesday
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Eurozone Consumer Confidence, Thursday
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BOE interest rate decision, Thursday
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Interest rate decision and press conference by the Swiss National Bank, Thursday
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US New Home Sales, Initial Jobless Claims, Thursday
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US Treasury Secretary Janet Yellen testifies before a budget subcommittee on Thursday
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Eurozone S&P Global Eurozone Manufacturing PMI, S&P Global Eurozone Services PMI, Friday
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US Durables, Friday
Some of the key movements in the markets:
Shares
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The S&P 500 was up 0.7% at 12:55 p.m. New York time
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The Nasdaq 100 fell 0.1%
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The Dow Jones Industrial Average rose 1.1%
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The Stoxx Europe 600 rose 1%
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MSCI World Index up 0.5%
currencies
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The Bloomberg Dollar Spot Index fell 0.4%
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The euro rose 0.5% to $1.0724
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The British pound rose 0.8% to $1.2270
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The Japanese yen rose 0.2% to 131.56 per dollar
cryptocurrencies
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Bitcoin fell 1.1% to $27,668.98
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Ether fell 2.2% to $1,760.36
Bind
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The 10-year government bond yield rose four basis points to 3.47%
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Germany’s 10-year yield was little changed at 2.11%
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The 10-year UK government bond yield rose two basis points to 3.30%
raw materials
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West Texas Intermediate Crude fell 1.6% to $65.70 a barrel
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Gold futures rose 0.3% to $1,997 an ounce
This story was created with the support of Bloomberg Automation.
–Assisted by Isabelle Lee, Vildana Hajric, Emily Graffeo, Carly Wanna, Angel Adegbesan and Edward Bolingbroke.
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