Banking sector jitters could spell more pain for stocks as the Fed’s battle with inflation continues

The aftershocks of the collapse of three U.S. banks in less than a week could be more painful for stocks in the coming weeks by creating new hurdles for the Federal Reserve in its fight against inflation, strategists from the market.

US authorities, including the Fed, Treasury and Federal Deposit Insurance Corp., jointly announced on Sunday evening that Signature Bank had collapsed over the weekend, following the bankruptcy of Silicon Valley Bank on Friday and the closing of Silvergate Bank on Wednesday. The plan allowed SVB and Signature depositors to access all their money on Monday.

The regulatory response also included a new Fed program, called the Bank Term Funding Program, or BTFP, to lend money to banks in a way that values ‚Äč‚Äčtheir collateral at par.

While many economists expect stability to return to the banking system, some market strategists fear the Fed will be forced to ease its interest rate hikes, prolonging its battle against inflation and making potentially even more damage to the stock market in the process.

If the Fed halts or slows its rate hike program, “it will ultimately have to do more to slow things down later,” potentially creating more “instability” for markets and the economy, said Neil Dutta, head of economics at Renaissance Macro Research. .

Other strategists said the trend already seemed to be playing out in the markets as investors flocked to the safety of government bonds on Monday, while the Dow Jones Industrial Average

DJIA

finished lower for the fifth consecutive session, its longest losing streak since September.

Simon Ree, a former Wall Street trader and author of ‘The Tao of Trading’, noted that equities were not reacting positively to the latest drop in bond yields, a sign that investors may be growing increasingly concerned about a recession. , even as investors see the chances that the Fed may ease its rate hikes.

Treasury yields have fallen sharply over the past three days, the 2-year yield

TMUBMUSD02Y

falling more than 100 basis points from its high on Thursday, according to FactSet data. It stood at 4.030% Monday afternoon in New York. against 5% on Thursday. Yields and bond prices move in opposite directions.

Since the market opened on Thursday, the S&P 500 has fallen more than 3%, according to FactSet data. Additionally, the Cboe Volatility Index

VIX

,
otherwise known as Vix

VIX

or Wall Street’s “fear gauge” hit its highest level since October on Monday, according to FactSet data, climbing north of 25.

Falling bond yields that have yet to boost equities may be a sign that “inflation concerns are taking a back seat here, and the market is more focused on a real sort of risk-free move,” he said. Ree at MarketWatch.

Stocks have generally rallied in recent months on any indication that the Fed might take a less aggressive stance on interest rates. According to Mohannad Aama, portfolio manager at Beam Capital, if the Fed changes its policy direction due to nervousness about potential contagion risks in the banking sector, it could hurt stocks instead of helping them.

“Pausing because you think there’s systemic risk in the banking industry, or for some other reason, is different from saying ‘our job is done here,'” Aama told MarketWatch by phone.

Still, should the Fed hike another 25 basis points next week, as widely expected, the outlook for markets could remain bleak, strategists said. Investors still need to see how the inflation data plays out in the coming months, although they will get another update on Tuesday when February’s Consumer Price Index is released.

Economists polled by The Wall Street Journal expect inflation to slow to a 6% year-on-year pace from 6.4% in January. That’s a far cry from the Fed’s 2% annual target.

The Fed also needs to monitor how quickly concerns about the stability of the banking system fade away, Steven Kelly, senior research associate at Yale’s Financial Stability Program, said in a phone interview with MarketWatch.

Kelly expects the feds to be successful in restoring confidence, but “if they start announcing ease after ease, then you may need to see more accommodative monetary policy,” he said.

Moreover, if contagion fears subsided relatively quickly, markets still appear to be bracing for greater economic backlash if banks cut lending, according to George Saravelos, co-head of global currency research at Deutsche Bank.

“The market is sending a consistent message today: it fears a US recession is about to begin,” he said in a note to clients.

U.S. stocks mostly ended lower on Monday, along with the S&P 500 index

SPX

down 0.2%, according to FactSet data, while the Dow

COMP

fell for a fifth straight day, its longest losing streak since September. The SPDR S&P Regional Banking ETF

CREATE

fell more than 12%. The Nasdaq Composite

COMP

rose 0.5%, making it the only index to end higher.

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