Banking Sector Worries Ease, But Market Struggles To Rally Amid Tightening Conditions

(Tuesday Market Open) The first quarter is coming to an end amid growing realization in the market that even if the economy avoids a full-fledged banking crisis, current financial conditions and tightening monetary policy aren’t conducive to a rally.

That sound you hear is Wall Street exhaling a bit, as it appears the worst of this month’s banking turmoil is behind. Yields rose and the dollar eased Monday as the “flight to safety” trade slowed. But the recent events still could have a negative impact during the current lull between the recent Federal Reserve meeting and the start of earnings season in mid-April.

Info tech, which carried the market last week, slumped as the new week began. Traditionally, higher yields can hurt growth areas of the market like tech. Mega-cap tech stocks slumped again in premarket trading Tuesday.

As a result, the S&P 500® index—where mega-cap tech stocks like Apple (AAPL) and Microsoft (MSFT) dominate the weighting—at one point yesterday was barely higher even though 80% of its components were up for the day. Small-caps, meanwhile, got off to a strong start this week thanks to regional bank strength following signs of industry stability. That’s subject to headline risk, however, as the ship hasn’t necessarily sailed on more volatility.

Morning rush

• The 10-year Treasury note yield (TNX) climbed 3 basis points to 3.55%.
• The U.S. Dollar Index ($DXY) traded slightly lower at 102.53.
• The Cboe Volatility Index® (VIX) futures are flat at 20.64.
• WTI Crude Oil (/CL) is up 0.47% to $73.15 per barrel.

One level to watch is 3.5% for the 10-year Treasury yield. That’s approximately the 200-day moving average (MA), and the market traded on both sides of it Monday. We might see yields continue to pivot around this area until the market gets a better sense of the Fed’s next steps.

Eye on the Fed

The main central bank event is at 10 a.m. today, when Fed Vice Chair for Supervision Michael Barr testifies on bank oversight before the Senate Committee on Banking, Housing, and Urban Affairs. He goes before the House Financial Services Committee on Wednesday.

Barr’s testimony might attract the market’s attention for what he says about the health of U.S. banks and any change in how the Fed approaches oversight in the wake of recent bank turmoil. You can watch it live on the committee’s website.

In comments released Monday ahead of his testimony, Barr called the banking system “strong and resilient,” echoing similar language used recently by Treasury Secretary Janet Yellen and Fed Chairman Jerome Powell. He also called the failure of Silicon Valley Bank a “classic case of mismanagement.” From the language he used, it seems Barr wants to emphasize that the recent banking instability was a relatively isolated event.

• That’s not all from the Fed this week. A host of Fed speakers crowd Friday’s calendar. The question is how hard a line they take on fighting inflation even as the market builds in talk of a recession and interest rate cuts. It’s unclear which side will win this tug-of-war, and also whether any divisions might be developing within the Federal Open Market Committee (FOMC) between hawks and doves.
• The market, for its part, takes the dovish side. Futures trading indicates not just one but several possible rate cuts before the end of the year, according to the CME FedWatch Tool. However, the Fed’s most recent projections show no rate cuts this year, and it’s hard for the Fed to suddenly veer the way the market points.
• This might be a case where the market—by way of data and possibly tighter credit conditions—slowly leads the Fed into a more dovish mode. At this point, it’s easier to see the market being right about the rate path, and the Fed, to its credit, has given itself an off-ramp by saying data will guide its decisions. The market has taken control of the wheel and has laid out what’s likely with all the information available.
• As of this morning, futures price in about a 50-50 chance of a 25-basis-point rate hike in May and a 93% probability that interest rates will fall below current levels by the end of the year. That includes a 11% chance the target range could drop below 4% from the current 4.75% to 5%, according to the FedWatch Tool. This isn’t necessarily bullish, by the way. The Fed rate cuts being priced in would likely occur if there’s a recession.

What to Watch

Data highlights this week include the final government read on Q4 Gross Domestic Product (GDP) due early Thursday. Also of note are the February Personal Consumption Expenditure (PCE) prices and Chicago Purchasing Managers Index (PMI) on Friday.

PCE and core PCE were both elevated in January, growing 0.6%. Analysts expect just a small dip in the pace of February PCE price growth to 0.5%, according to Trading Economics. Year-over-year core PCE is seen rising 4.7% in February, unchanged from January’s monthly growth. The Fed targets 2% but doesn’t expect inflation to return to that level until 2025.

A really hot PCE print—if that’s what we get—could throw a wrench into growing ideas of the Fed possibly cutting rates later this year, though of course it’s only one data point.

Before all that, investors get a look at March Consumer Confidence from the Conference Board shortly after today’s open. Consensus is for a slight dip to 101.5, from the prior 102.9, according to Briefing.com.

Confidence is down two months in a row, possibly meaning less demand for major items like appliances, cars, and homes. Inflation expectations dropped last time to 6.3% for the 12 months ahead, so we’ll see if that positive trend continues.

Stocks in Spotlight

Walgreens Boots Alliance (WBA) kicked off a busy earnings day by beating analysts’ expectations and reaffirming previous guidance. Earnings per share reached $1.16 and revenue totaled $34.86 billion. Wall Street analysts had expected earnings per share of $1.11 on revenue of $33.4 billion, according to Earnings Whispers. The company said “strong core business growth is more than offset by lapping peak COVID-19 demand,” a sign of the challenging comparisons the company faces to a year ago when pandemic vaccine sales spiked.

Micron: Semiconductor chip maker Micron (MU) will report earnings this afternoon, on the heels of solid earnings from chip maker Nvidia (NVDA) earlier this month. MU is a leader in memory and storage technologies, which have applications for automobiles, artificial intelligence, smartphones, and data centers, among other areas. That makes its earnings report a useful update on general technology demand. The company’s been wrestling with inventory issues, and memory demand has been declining so margins will likely be in focus.

Lululemon (LULU) opens its books after the close today. The last time the athletic apparel retailer reported, its management called the sales environment “challenging,” and shares haven’t recovered since. It may seem like a long time since the holidays, but tomorrow offers a look at LULU’s performance for that period.

Alibaba (BABA) climbed more than 6% as the e-commerce firm plans to split into six units that will individually raise funds and explore initial public offerings.

Market Minutes

Energy shares led gains on Wall Street yesterday as crude oil surged. Financials, industrials, and materials also performed well on a day without much data or earnings news, though sentiment around the banking system did seem to improve. There’s an old market saying that it’s hard to have a rally without the participation of financials, so that remains an important sector to watch. That said, most sectors rose yesterday, which can be a sign of healthy buying interest

Another key element is the 4,000 level in the S&P 500® index (SPX). The index climbed above 4,000 briefly intraday Monday but once again finished well below that round number, as there doesn’t seem to be much buying conviction at that level or above. The SPX has only closed above 4,000 once since early March.

Less than one-quarter of SPX stocks currently trade above their 50-day MA, and rallies have been led by a small number of mega-cap tech names like AAPL, MSFT, and Meta Platforms (META) lately. We need to see strength outside of that realm, because despite their heavy weighting, these three stocks aren’t likely to keep propping up the rest of the market by themselves.

Thinking cap

Ideas to mull as you trade or invest

Inversion reversion: The so-called “yield curve inversion” has been the market’s bogeyman for a long time now, but things are changing—possibly for the worse. As a reminder, long-term Treasury notes usually pay higher yields than shorter-term ones, rewarding investors for tying up their money in a longer-duration asset. Over the last year, successive Fed rate hikes to fight inflation caused the 2-year Treasury yield to climb well above the 10-year Treasury yield, an “inverted” scenario that gave the 2-year yield a 100-basis-point premium earlier this month—the highest since 1981. That’s one reason why many gravitated toward short-term assets like Series One Treasury bonds, which at one point last year yielded more than 9%.

Treasury twist: This month, the Treasury market did a complete about-face as ideas of a Fed pause or even rate cuts took hold during the banking turmoil. In a bout of volatility unlike anything veteran traders had seen in more than 20 years, the 2-year yield plunged from 5% on March 6 to below 4% Monday. The 10-year yield also declined, but not as much because it’s less sensitive to Fed rate policy. It recently traded at 3.48%. The inversion still exists, but the 2-year Treasury’s yield premium is now less than 50 basis points, half of the level several weeks ago.

Why worry? We hear about yield-curve inversion being predictive of recessionary times ahead, but re-steepening can be most ominous, and we’re starting to see that. Historically, the current situation has been far more predictive of when recessions begin, and a curve steepening typically happens when the slowdown gets close, meaning we could be in the eye of the storm. A slowing economy could especially hurt so-called “cyclical” sectors like industrials (think airlines and auto makers) and consumer discretionary companies (restaurants and hotels) that rely on a healthy consumer. Recession could be the new “bogeyman” if yield curve inversion crawls back under the bed.

Calendar

March 29: February Pending Home Sales

March 30: Q4 GDP-third estimate.

March 31: March Chicago PMI, February Personal Consumption Expenditures (PCE) prices, February Personal Income and Spending, and University of Michigan Final March Consumer Sentiment.

April 3: February Construction Spending and March ISM Manufacturing Index and expected earnings from Yum Brands (YUM).

April 4: February Factory Orders and February Job Openings and Labor Turnover Survey (JOLTS).

 

TD Ameritrade® commentary for educational purposes only. Member SIPC.

 

Image sourced from Shutterstock

This post contains sponsored advertising content. This content is for informational purposes only and not intended to be investing advice.