Yields Plunge, Volatility Leaps as Market Sees Fed Taking Cautious Approach to Rate Hikes

(Monday Market Open) Stock index futures erased steep overnight gains even as hopes built for just a 25-basis-point rate hike after the government’s move Sunday to protect depositors at the failed Silicon Valley Bank SIVB.

Though bank stocks remained under pressure early Monday following last week’s sharp losses for some, investors now see no chance of a 50-basis-point rate hike next week. Instead, the CME FedWatch Tool points toward a 70% probability of a 25-basis-point increase, basically what it had been before Federal Reserve Chairman Jerome Powell raised concerns last week in testimony to Congress. At one point last week, chances of a 50-basis-point hike topped 70%.

Also, chances now are building that the Fed might simply not raise rates next week. There’s a 30% chance of that, the FedWatch Tool suggests. The market now appears to be pricing in a peak rate of around 4.8%, down well above 5% last week. This could certainly change, but the market is now basically predicting a 25-basis-point hike in March and then a pause, followed by a chance of rates actually going down by this autumn.

In other words, investors appear to believe that last week’s bank failure and the Fed’s quick response could at least make Federal Open Market Committee (FOMC) members think twice about rapidly increasing the pace of rate hikes, perhaps out of concern that something else might “break” as financial conditions tighten. However, things have fluctuated extremely quickly, so the failure of Sunday night’s rally to extend into this morning could reflect more uncertainty about the path ahead.

Another wildcard is inflation data. If tomorrow morning’s February Consumer Price Index (CPI) report and Wednesday’s Producer Price Index (PPI) report continue to show “hot” pricing, the Fed could be in a very tough position on what to do next.

Treasury yields continued to plunge early Monday, a possible sign of investors piling into Treasuries amid economic uncertainty. The 10-year Treasury yield recently was down 19 basis points at 3.5%. There have been wild swings across the curve, with the 2-year Treasury yield now down about 100 basis points from last week’s peak above 5%. This is the biggest three-day decline in the 2-year Treasury yield since 1987.

With yields sinking fast, we’re basically seeing a reversal of the last year’s trading activity. The Nasdaq Composite ($COMP), which had been under pressure due to its heavy inclination toward rate-sensitive technology stocks, was actually performing best of the major indexes early Monday. Meanwhile, the small-cap Russell 2000® (RUT), loaded with regional bank stocks, is taking it on the chin.

Volatility, which had eased late Friday after a quick jump to four-month highs, again climbed sharply early Monday and sits not far below Friday’s peak levels. This is a day to trade carefully if you’re trading at all. Keep track of your position sizes and perhaps consider scaling them back. Things could move quickly.

Just in

 

Stock index futures initially jumped 1% late Sunday after the Federal Reserve Board announced it will “make additional funding available to eligible depository institutions to help assure banks have the ability to meet the needs of all their depositors.” The Fed said this action will bolster the capacity of the banking system to safeguard deposits and ensure the ongoing provision of money and credit to the economy. It’s also prepared to address any liquidity pressures.

Investors might also have been reassured by the Fed’s claim that “the capital and liquidity positions of the U.S. banking system are strong and the U.S. financial system is resilient.”

The Federal Reserve’s been raising rates for nearly a year and continues to suggest more hikes to come. The yield curve inverted by 100 basis points recently, a warning shot that there’s real stress for the system. None of this is normal, and there’s been a lot of talk about the possibility of something “breaking.”

We may be seeing the first signs of that. Last week’s instability in the banking industry weighed heavily on financial, tech, and small-cap stocks, perhaps providing an indication of what’s out there in terms of risk. The small-cap Russell 2000 index® (RUT) took the biggest hit, falling almost 3% Friday due in large part to its heavy exposure to regional banks.

There’s a phrase: Things happen fast. Last week’s banking issues show what can happen in a drastically different interest rate environment that’s changed extremely quickly. Still, to put things in perspective, there are key differences between banks like JPMorgan Chase (JPM), Bank of America (BAC) and the much smaller SIVB that was in the spotlight last week.

“Silicon Valley Bank’s failure made waves across the financial markets,” said Collin Martin, fixed income strategist at the Schwab Center for Financial Research. “However, the U.S. banking system is still relatively healthy. Capital ratios, a measure of banks’ ability to cover their loans, have declined over the last year but are still at adequate levels ”

Morning rush

• The 10-year Treasury note yield (TNX) plunged another 19 basis points to 3.5% and is now down more than 50 basis points from last week’s four-month peak.
• The U.S. Dollar Index ($DXY) was down slightly but remained close to recent highs at 104.23.
• The Cboe Volatility Index® (VIX) futures jumped above 29 this morning.
• WTI Crude Oil (/CL) dove to $72.76 per barrel, a one-month low.

Volatility re-emerged in a big way late last week, with the VIX jumping above 28 after being mostly below 20 in recent weeks. It’s a sea change from the calmness investors had grown used to over the last few months. There is some seasonality to this, as VIX often rises this time of year, just often not so fast.

Eye on the Fed

Combined with last week’s jobs report, inflation and Retail Sales data over the coming days could help shape the central bank’s thinking on rates heading into its meeting next week.

Unfortunately (or fortunately, depending on your feelings about the Fed), the central bank won’t be around this week to comment on data. Its quiet week has started ahead of the Federal Open Market Committee (FOMC) meeting next Tuesday and Wednesday. This means the Fed will watch the data quietly and investors can only guess what Powell and company might be thinking.

What to Watch

Three critical reports arrive this week ahead of the March 21–22 FOMC meeting, all carrying potential rate implications.

Consumer Price Index (CPI): February’s CPI report is on deck tomorrow morning before the open. Headline CPI in January rose 0.5% month-over-month, and core CPI, which strips out food and energy, climbed 0.4%. Both were in line with analysts’ expectations but up sharply from December’s upwardly revised readings. Housing costs continued to accelerate, climbing 0.8% in January, but vehicle and medical care costs fell.

For February, CPI consensus, according to Trading Economics, is:

• CPI 0.4%, versus 0.5% in January.
• Core CPI: 0.4%, versus 0.4% in January.

The CPI is the next major benchmark data point, and we’ll have to see what direction the interest rate market takes afterward.

Producer Price Index (PPI) and Retail Sales data for February are both due Wednesday morning. PPI could provide evidence of whether price pressure has eased in the wholesale market, a key element for companies trying to protect their margins. Headline PPI and core PPI rose 0.7% and 0.5%, respectively, in January, both accelerating from December to their biggest gains in months.

Analysts expect PPI and core PPI to ease just a bit in February, to 0.3% and 0.4%, respectively, according to Trading Economics.

Retail Sales climbed 3% month-over-month in January (2.3% if you strip out automobile sales). Remember that Retail Sales aren’t adjusted for inflation, so rising prices of goods can influence the final numbers. Consensus for February Retail Sales growth is a huge slowdown from January at 0.3%. We’ll discuss this more tomorrow.

Stocks in Spotlight

Investors get a glance later this week at quarterly results from FedEx (FDX), Adobe (ADBE), and Dollar General (DG).

Market minutes

Here’s how the major indexes performed Friday:

• The Dow Jones Industrial Average® ($DJI) dropped 345 points, or 1.07%, to 31,909.
• The Nasdaq Composite® ($COMP) fell 1.76% to 11,138.
• The Russell 2000® (RUT) plummeted 2.95% to 1,772.
• The S&P 500® index (SPX) fell 56 points, or 1.45%, to 3,861, the weakest settlement since January 5.

U.S. stocks tumbled to the lowest levels in more than two months Friday as SIVB’s failure shook the financial sector. The market extended losses then rebounded modestly in afternoon trading as investors grappled with potential implications of the Federal Deposit Insurance Corp.’s (FDIC) shutdown of SIVB, the largest U.S. bank failure since the 2008 financial crisis.

SIVB’s collapse came a day after the bank, once a top lender in the tech sector, was unable to raise more than $2 billion in capital. The failure weighed heavily on shares of regional banks, though large institutions held up better, JPM, for example, jumped more than 2% by the weekend close.

Thinking cap

Ideas to mull as you trade or invest

Get a job: Labor force participation drew attention as financial media chatted away Friday about positive aspects of the jobs report. And participation did indeed crawl slightly higher, to 62.5%. In addition, the government’s household survey showed a 269,000 decline from a year ago in the number of people not in the labor force. The “cup-half-full” argument is that rising wages continue to draw more people back to the labor market, reducing the supply of unemployed workers and possibly easing wage pressure (a market where more people have jobs tends to reduce competition to fill positions, cooling the wage environment). Still, a 62.5% participation rate is up just marginally from 62.2% a year ago, though it’s closer to pre-pandemic levels. The trend is in the right direction, but getting people back to work is an awfully slow process.

Tracking tech: Are tech layoffs starting to affect the overall jobs market? The wishy-washy answer is maybe yes and maybe no. On the maybe yes side, jobs growth in February mostly occurred across sectors like leisure and hospitality, retail sales, and government. The transportation and warehousing sector, sometimes seen as a proxy for tech, lost 22,000 jobs. The information industry also lost jobs, though losses were worst in the motion picture and sound subsectors. On the maybe not side, the economy added 311,000 positions despite the flurry of recent tech layoff announcements. Perhaps laid-off techies quickly found work in other sectors. We’ve heard, for instance, that some landed in other industries needing their expertise. The jobs report may not be the best way to track the impact. Instead, focus on jobless claims, which ticked up last week to the highest level in some time above 200,000. If they keep rising, it could reflect tech layoffs hitting home as people run out of severance pay and file for unemployment benefits.

Consumer in spotlight: Job market strength didn’t necessarily play well across a rate-sensitive Wall Street Friday, but it may have helped one particular sector: consumer discretionary. The sector was the third-best performer of the day Friday behind consumer staples and health care.  Shares of several major discretionary stocks finished flat to slightly up Friday, including Dollar Tree (DLTR), Tesla (TSLA), McDonald’s (MCD), and Chipotle (CMG). Ulta (ULTA) got a boost Friday as Baird raised the firm’s price target and kept an outperform rating on shares. ULTA has some product resiliency because it caters to consumers across the economic spectrum, arguably making it more of a consumer staple than a discretionary stock. Despite outperforming most other sectors Friday, consumer discretionary is down 7.2% over the last month, a much worse performance than the SPX’s nearly 5% decline over the same period.

Calendar

March 14: February Consumer Price Index (CPI) and Core CPI

March 15: February Retail Sales and February Producer Price Index (PPI).

March 16: February Housing Starts and Building Permits and expected earnings from Dollar General (DG) and FedEx (FDX).

March 17: February Industrial Production, February Leading Indicators, and March Preliminary University of Michigan Consumer Sentiment.

March 20: No major data or earnings.

 

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

 

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