Sentiment Improves Amid Signs Of Stability In Regional Banking Stocks, With Fed Speakers Ahead

(Monday Market Open) Stock index futures kicked off the week with fresh gains to build on Friday’s recovery rally, but more volatility may be ahead as participants eye a host of Fed speakers and key inflation data ahead. Banking sector health remains front and center as the quarter winds down.

This morning’s boost got more traction after Bloomberg reported that U.S. authorities were considering expanding an emergency lending program for banks, which could give First Republic Bank (FRC) more time to shore up its liquidity. However, stock futures were already higher overnight before that news.

Further support followed news that First Citizens Bank agreed to buy large parts of Silicon Valley Bank (SIVB), where the banking industry turmoil first surfaced several weeks ago. Regional bank stocks are rising on these industry news items early Monday, and on reports that outflows from regional banks to large banks weren’t as large as feared over the weekend. 

Eye on the Fed

As of this morning, there’s about a 35% probability of a 25-basis-point rate hike at the Federal Reserve’s May meeting, according to the CME FedWatch Tool. That’s compared with a 70% chance a month ago, a huge reversal that reflects how banking instability can disrupt the Fed’s plans.

Earlier this month, there was talk of the Fed needing to eventually consider a peak rate of 6% (the current target range is 4.75% to 5%) to tame inflation. Now, worries that higher rates could cause more things to “break” in the financial system have the market anticipating a more than 60% probability of the Fed cutting rates by 25 basis points by the time of its July meeting.

• It may sound bullish to contemplate potential rate cuts after nine consecutive rate increases, but that’s not the way the market sees it, judging from recent Wall Street weakness. Instead, investors view a Fed pivot as a possible reaction to economic softening. Market participants piled into longer-term Treasuries, utility and staples stocks, and gold last week—classic signs of a “risk-off” trade that often gains traction ahead of a recession.
• Fed speakers are in the spotlight early this week, starting after today’s close when Fed Governor Philip Jefferson will deliver remarks about “Implementation and Transmission of Monetary Policy.” He’s followed at 10 a.m. tomorrow by Fed Vice Chair for Supervision Michael Barr, who will testify on bank oversight before the Senate Committee on Banking, Housing, and Urban Affairs.
• Barr’s testimony might attract the market’s attention for anything 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.
• The latest Fed data show signs the banking crisis may be easing, Barron’s reported over the weekend. The Fed provided $354 billion to banks through its various credit facilities through last Wednesday, a $36 billion increase from the total a week earlier. There was also a $42.6 billion drop in banks’ regular discount window borrowing.

 

Even if the Fed is done hiking, policy might get increasingly tight. Falling inflation and tightening credit conditions—with rates staying at 5%—is restrictive for the economy, Schwab analysts say. Credit tightening from the banking crisis could exacerbate what was already in the pipeline. It’s hard to pin down, but some analysts believe credit tightening could have an economic impact equivalent to a hike of 50 basis points or more in the fed funds rate, Barron’s noted.

Morning rush

• The 10-year Treasury note yield (TNX) rose 8 basis points to 3.46%.
• The U.S. Dollar Index ($DXY) is up slightly at 103.3.
• The Cboe Volatility Index® (VIX) futures fell slightly to 21.42.
• WTI Crude Oil (/CL) rose to $70.20 per barrel.

The VIX traded in a wide range again Friday, capping off a week of extreme volatility. Heading into the weekend, it fell back below 22, versus peaks of nearly 30 several days earlier. This sort of dramatic move in the VIX often happens when there’s uncertainty about the economy, rates, or company health, and it’s likely the VIX could remain elevated until investors feel more confidence in the banking system.

We’re not there yet if major stock indexes drop dramatically and rapidly based on a rise in credit default swaps—the cost to insure against default in the company’s debt—for a single major bank. That’s what happened in the early morning hours Friday amid concern about Deutsche Bank (DB), demonstrating the market’s heightened sensitivity to certain elements that many investors don’t usually follow or even think about.

What to Watch

The quarter wraps up this week, and that means we’ll get some traditional end-of the-quarter data, including a final government read on Q4 Gross Domestic Product (GDP) due early Thursday. Also standing out are the February Personal Consumption Expenditure (PCE) prices and Chicago Purchasing Managers Index (PMI) on Friday.

The Fed closely watches PCE prices, so that’s the first major data point after last week’s Federal Open Market Committee (FOMC) meeting that’s likely to play into the central bank’s decision. PCE and core PCE were both elevated in January, growing 0.6%. We’ll preview analysts’ expectations for the data later this week.

Stocks in Spotlight

Trip to the pharmacy: Walgreens Boots Alliance (WBA) is expected to report earnings Tuesday morning. Shares fell 6% in early January, the last time WBA reported, and just haven’t gotten out of bed since. They recently traded near five-month lows. The company has a long record of beating Wall Street analysts’ expectations for earnings and revenue, and it has been transitioning into a broader healthcare services company with the recent $8.9 billion purchase of Summit Health-CityMD. Wall Street analysts expect earnings per share of $1.11 on revenue of $33.4 billion, according to Earnings Whispers.

Chip shop: Semiconductor chip maker Micron is expected to report Tuesday afternoon. This follows solid earnings from chip maker Nvidia (NVDA) earlier this month.

Lululemon (LULU) is another one to watch for earnings after tomorrow’s close.

Market minutes

Here’s how the major indexes performed Friday:

• The Dow Jones Industrial Average® ($DJI) added 132, or 0.42%, to close at 32,237.
• The Nasdaq 100® (NDX) rose 0.3% to 12,767.
• The Russell 2000®(RUT) climbed 0.85% to 1,734.
• The S&P 500® index (SPX) rose 0.56% to 3,970.

Stocks showed some resilience Friday, rebounding from sharp early losses that were fueled by banking worries. That said, try to keep it in perspective, because the usual suspects—Apple (AAPL) and Microsoft (MSFT, which together compose more than 13% of the weight of the SPX—both charged higher late Friday, helping to lift the SPX despite weakness across many sectors. Info tech and communication services sectors each rose more than 1.5% Friday, but no other sectors finished in the green. Financials, utilities, and energy were laggards.

For the week, the SPX rose 1.4%, but the equal-weight SPX (SPXEW), in which all 500 S&P stocks have an equal impact on the index, rose less than 0.8%. Solid gains during the week for AAPL, GOOGL, and Meta (META), as well as Nvidia (NVDA)—another stock with a large weighting in the index—helped the SPX outpace the SPXEW.

Talking Technicals: The SPX rebounded Friday after sinking below its 200-day moving average (MA) of 3,932 early in the session. The close at 3,970 puts it roughly in between technical support at the 200-day MA and psychological resistance at 4,000, which is just below the 50-day MA of 4,014. Despite recent gyrations in the market, the SPX hasn’t shown much traction in testing those resistance levels, and buyers appeared to show up on tests of support. We’ll see if that continues this week.

Thinking cap

Ideas to mull as you trade or invest

VIX watch: Recent choppiness puts the focus squarely on the Cboe Volatility Index (VIX), which made huge swings between 20 and 30 last week after recently falling below 20 for the first time in nine months (20 is approximately the historic average, and anything over 25 tends to raise eyebrows). While the VIX can give you a sense of the near-term volatility outlook, it also helps to check the futures curve, which recently has behaved a bit unusually. Looking ahead the next few months, futures are basically flat, with almost all contracts out to November hovering near 24 as of Friday’s close. The VIX finished under 22 that day. A more normal curve is to see back-dated contracts trading lower than the front ones, reflecting ideas that even if things are bumpy now, they likely could get smoother. That’s not the way things look now, but futures aren’t building in expectations of any severe volatility, either.

Crowd think: Speaking of things people tend to expect—like volatility falling over time—takes us to a term called “recency bias.” That means our tendency to think things will continue as they have been, especially if it’s been a while since they changed. It’s easy to fall into this thinking if you trade the markets, but it can leave you unprepared when things change—as they nearly always do. Recency bias may even have had an impact recently on central banks, which didn’t seem ready for bank failures in Europe and the United States despite steadily rising rates. To avoid recency bias in your financial planning, consider giving your portfolio a “stress test” by looking it over and asking if you’re prepared for a recession or some other major event.

Risky business: Short-term government debt gained popularity after the 2-year Treasury note yield jumped above 5% earlier this month, 100 basis points higher than the 10-year Treasury note’s yield for the first time since 1981. Even though yields are down from peaks and there’s been some narrowing of the 2-year note’s premium, the 2-year note remained above 3.7% Friday, and shorter-term notes of one year or less still offered 4% or higher yields versus under 3.4% for the 10-year note. That said, some experts suggest investors carefully consider how they approach short-term versus long-term fixed income investment. “With the Federal Reserve poised to change direction, investors who have been investing in very short-term securities may soon face ‘reinvestment risk,’” writes Cooper Howard, a director of fixed income strategy at the Schwab Center for Financial Research. These investors, Cooper says, ” may soon face the prospect of lower short-term rates—rates that could even be lower than current long-term rates.”

Calendar

March 28: March Consumer Confidence and expected earnings from McCormick (MKC) and Walgreens Boots Alliance (WBA).

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).

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

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