The "V" Word: Volatility Dominates as Investors Monitor Bank Developments, Await FOMC Meeting

(Monday Market Open) There’s an elephant in the room this week—the Federal Reserve. Its meeting and interest rate announcement Wednesday are likely to crowd out almost everything else, and unlike most times when the Fed meets, the outcome is far from predictable two days before the decision.

The CME FedWatch Tool puts odds of a 25-basis-point rate hike at 60% this morning. That’s as close to a coin toss as you’re likely to see this close to a Federal Open Market Committee (FOMC) meeting and could drive volatility the next few days until we actually have an answer.

Alongside FOMC prep, markets remain focused on banks following the forced takeover of Credit Suisse by UBS that was brokered by Swiss regulators. This marks the latest effort by governments around the world to stifle a potential crisis threatening the banking sector. UBS agreed to buy Credit Suisse for 3 billion Swiss francs, or $3.2 billion, with the combined bank to have $5 trillion in assets.

Stock index futures had a volatile night, falling more than 1% at times before clawing back toward unchanged levels soon before the opening bell. Treasury yields also vacillated. Both are signs that uncertainty around banks and the FOMC put markets in a fluid situation early this week.

Morning rush

• The 10-year Treasury note yield (TNX) is down more than 2 basis points at 3.37%.
• The U.S. Dollar Index ($DXY) is also lower at 103.44.
• The Cboe Volatility Index® (VIX) futures remain elevated at 26.5.
• WTI Crude Oil (/CL) recently traded lower at $66.14 per barrel after falling to 15-month lows under $65 overnight.

Keep an eye on crude and the dollar this week. Both being lower early Monday suggests growing economic concerns, with dollar weakness indicating increased sentiment that the Fed won’t hike rates or is nearly done. Gold is also up, another sign of investors possibly pricing in the end of this tightening cycle.

Eye on the Fed

As the Fed considers its move, inflation remains a worry and there’s also concern about possible tightening in the credit market, a scenario that could slow the economy. The Fed has many plates spinning in the air ahead of the meeting.

“Risks in the banking sector may be contained due to the Fed’s efforts but the emerging risk is that credit availability declines,” says Charles Schwab’s Chief Fixed Income Strategist Kathy Jones. She notes:

• Banks had already begun to tighten up on credit before the recent financial market turmoil. This is likely to make them more cautious.
• More cautious banks mean less lending, which translates into less economic activity. Business investment and consumer spending tend to slow.

Market expectations ahead of the FOMC meeting have been “all over the place,” according to Kathy. She thinks it would be prudent to pause rate hikes at this meeting but notes the focus on inflation could drive the Fed to raise rates by 25 basis points. If that happens, she says, it’s likely the last one of the cycle.

This won’t be a typical Fed meeting, with just a rate decision, some comments from Fed Chairman Jerome Powell, and then back to regularly scheduled business. Instead, we’ll get the full-court FOMC press, including future rate and economic projection. Markets have been rapidly building in rate cuts later this year. Will the Fed’s dot plot back up these projections? It’s worth noting that the 2-year Treasury yield fell below fed funds futures last week, something that historically has indicated the end of Fed tightening cycles. 

What to Watch

The Week ahead: After two weeks of absorbing critical data, including payrolls, inflation, retail sales, and sentiment, this week could feel like a refreshing spring break (if it weren’t for the little matter of the Fed meeting, of course).

Numbers-wise, the only major report early this week is Tuesday morning’s February Existing Home Sales figures. It follows the better-than-expected Housing Starts and Building Permits that came out last week and reinforced ideas of an improving home market. Building permits and starts tend to reflect the higher end of the home-buying market, because people buying pricey brand-new homes typically have the deep pockets to afford them.

That’s why existing home sales might be a better indicator of overall consumer confidence, as they are less influenced by the small minority of people who are “recession-proof,” so to speak. Existing home sales are expected to rise 0.5% month over month in February, according to Trading Economics. New home sales for February are expected Thursday.

Stocks in Spotlight

Pacific rim: In this slow period of corporate reporting weeks before earnings season begins, seeing a Dow Jones Industrial Average® ($DJI) component share quarterly results is like spotting the first robin of spring. Well, the robin chirps tomorrow afternoon when Nike (NKE) reports, putting the spotlight squarely back on China’s reopening progress.

Barron’s reported over the weekend that sportswear demand has surged in China recently and is expected to grow by double-digits this year—perhaps good news for the company with a swoosh. NKE looks to build on its previous strong quarter, and analysts look for revenue of $11.4 billion and earnings per share of $0.51, according to Earnings Whispers.

Market minutes

Here’s how the major indexes performed Friday:

• The Dow Jones Industrial Average® ($DJI) dropped 384 points, or 1.19%, to 31,861.
• The Nasdaq 100® (NDX) slid 0.49% to 12,519.
• The Russell 2000® (RUT) fell 2.56% to 1,725, just above key technical support near 1,722.
• The S&P 500® index (SPX) dropped 43 points, or 1.1%, to 3,916, but rose 1.4% overall last week.

The financial sector remained under pressure Friday following Thursday’s report that some of the largest U.S. banks agreed to deposit as much as $30 billion in a government-supported attempt to stabilize First Republic Bank (FRC). U.S.-listed shares of Credit Suisse (CS) dropped sharply even after the troubled lender said it would borrow up to $54 billion from the Swiss National Bank.

• Regional bank stocks stayed on the front burner Friday as FRC shares sank another 30%. This could reflect investor concerns that more trouble might be lurking under the surface of some of these companies—and perhaps lack of confidence in the government’s ability to handle the situation. The possibility of another rate hike this week potentially exacerbates these fears amid ideas that something else could “break” due to rising rates. On the other hand, some analysts say the situation could help large banks by drawing more depositors seeking perceived stability.
• It appeared participants were shy about carrying long positions into the weekend with so much volatility around. Every sector ended lower Friday, though info tech did finish again at the top of the leader board as investors piled into shares of Microsoft (MSFT) and semiconductors like Nvidia (NVDA) and Advanced Micro Devices (AMD). However, the relatively decent performance of so-called “risk-on” parts of the market like tech shouldn’t distract us from noting that defensive sectors like consumer staples and utilities were also near the top of Friday’s leader board.
• Real estate is another sector to watch closely in coming weeks, especially if credit from regional banks starts to tighten. This could be a real drag on commercial real estate investment.

Talking Technicals: The 10-year Treasury note yield (TNX) managed to finish just above 3.4% on Friday after dipping slightly below 3.4% several times toward the end of the week. The low for the year is just below 3.34%, a level touched in early February right before the strong January jobs report. This range between roughly 3.35% and 3.4% is worth watching for signs of possible bottoming in the TNX, which hasn’t traded below that in more than six months. A drop under those levels might indicate additional investor fears about the economy. 

Thinking cap

Ideas to mull as you trade or invest

Bumpy rate outlook: There’s lots of talk about any potential Fed rate hike this week being the last of the cycle, and the futures market is certainly building the case for that. However, the future rate path depends on inflation, Schwab’s strategists say. Just as last week’s market surprises forced investors and market participants to reevaluate, more surprises can’t be ruled out, which could lead the Fed to stay on the inflation warpath longer than expected. One potential “X” factor in the inflation arena is China’s reopening.  Economic data from the country is already exceeding expectations by the widest degree in more than 15 years. The manufacturing purchasing managers index (PMI) rose into expansion territory in February for the first time in seven months, driven by a 23-month high in business confidence. The Fed’s path on rates could certainly complicate if it’s trying to address turmoil in the U.S. banking sector as demand from China sends global inflation higher. It’s tough to be a central banker at times like these.

Inflation concerns ease: Friday’s University of Michigan preliminary March Consumer Sentiment data had something for everyone, but it should be welcome news for the Fed and appeared to help push Treasury yields lower. The bad news was a headline of 63.4, when analysts had expected 67.2. That was the lowest since December, suggesting those surveyed believe their personal economic situations aren’t as good as in February, when the headline was 67.0. You can’t chalk this up to the heavily publicized recent bank failures, either, because most of the survey was finished before those occurred. The sunny side was one-year inflation expectations, which fell to a nearly two-year low of 3.8%. This could conceivably reflect people feeling some of the recent lower goods inflation in their everyday lives, though service prices keep climbing. It also lines up with last month’s falling retail sales growth, adding to evidence that consumers may be pulling back due to weakening sentiment. Does the weaker sentiment and spending reflect concerns brewing in the labor market? February’s jobs data looked healthy, but sometimes things are moving under the surface that become evident over time.

Crude tailwind? The drop to 15-month lows below $70 per barrel for WTI crude (/CL) last week hurt energy stocks and also raised concerns about a possible economic slowdown. In the long run, however, this could be a tailwind for the economy, according to the Organisation for Economic Cooperation and Development (OECD). It raised its 2023 and 2024 global economic growth projections to 2.6% and 2.9%, respectively, on Friday, up by 0.2 percentage points from its previous estimates, citing falling food and energy prices. /CL is down about 15% in just the last week to lows last seen in December 2021, and a softer energy market could potentially fuel better profit margins for many companies—especially in the transport arena. It also could take pressure off consumers, many of whom paid dearly to heat their homes this winter. Don’t get used to cheap energy, though. Less than two weeks ago the debate was about whether crude could get back to $100 per barrel this year. If the Fed stops hiking rates, a falling U.S. dollar would probably be bullish for crude. Also, we’re approaching summer, when demand historically rises as more travel occurs.

Calendar

March 21: February Existing Home Sales and start of 2-day FOMC meeting.

March 22: FOMC rate decision.

March 23: February New Home Sales and expected earnings from Accenture (ACN), General Mills (GIS), and Darden Restaurants (DRI).

March 24: February Durable Orders and Durable Goods.

March 27: Expected earnings from Carnival Corp. (CCL).

 

Image sourced from Shutterstock

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