Jitters in the banking sector could spell more pain for stocks as the Fed’s battle with inflation continues

Aftershocks from the collapse of three US banks in less than a week could hurt stocks even more in the coming weeks by creating new obstacles for the Federal Reserve in its fight against inflation, market strategists say.

U.S. authorities, including the Fed, Treasury and Federal Deposit Insurance Corp., jointly announced 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. Thanks to the plan, savers at SVB and Signature had access to 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 ​​their collateral at par.

While many economists expect stability to return to the banking system, some market strategists worry that the Fed will be forced to ease rate hikes, prolonging the fight against inflation and potentially further damaging the stock market.

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

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


ended lower for the fifth session in a row, the longest streak of losses since September.

Simon Ree, a former Wall Street trader and author of the book “The Tao of Trading,” noted that stocks did not react positively to the latest drop in bond yields, a sign that investors are increasingly concerned about a recession. even as investors deem it likely that the Fed could ease its rate hikes.

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


down more than 100 basis points from its peak on Thursday, according to data from FactSet. It stood at 4.030% on Monday afternoon in New York. down 5% on Thursday. Bond yields and prices move in opposite directions.

Since the market opened on Thursday, the S&P 500 is down more than 3%, according to data from FactSet. Also the Cboe Volatility Index


also known as the Vix


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

Lower bond yields that have yet to boost stocks could be a sign that “inflation concerns are taking second place here and the market is more focused on a true risk-free move,” Ree told MarketWatch.

Stocks have generally risen in recent months on any indication that the Fed could take a less aggressive stance on interest rates. Should the Fed change its policy stance amid jitters about potential contagion risks in the banking sector, it could hurt stocks rather than help them, according to Mohannad Aama, a portfolio manager at Beam Capital.

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

But if the Fed were to come up another 25 basis points next week, as widely expected, the outlook for markets could remain bleak, strategists say. Investors will have to wait and see how inflation numbers develop in the coming months, although they will receive another update on Tuesday when the February consumer price index is released.

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

The Fed also needs to monitor how quickly concerns about the stability of the banking system abate, Steven Kelly, a senior research associate at Yale’s financial stability program, said in a telephone interview with MarketWatch.

Kelly expects federal authorities to succeed in restoring confidence, but “if they start announcing facility after facility, then maybe you need to loosen monetary policy,” he said.

Should contagion fears ease relatively quickly, markets still appear to be bracing for a bigger economic downturn as banks borrow less, said George Saravelos, global co-head of currency research at Deutsche Bank.

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

US stocks closed largely lower on Monday, with the S&P 500 index


fell 0.2%, according to data from FactSet, while the Dow


fell for the fifth straight day, the longest streak of losses since September. The SPDR S&P Regional Banking ETF


decreased by more than 12%. The Nasdaq Composite


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


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