Wall Street Traders on Hold With Fed in Tough Spot: Markets Wrap
(Bloomberg) -- The stock market treaded water after retracing all of its losses since the start of the banking turmoil, with investors awaiting one of the most-challenging Federal Reserve decisions in recent memory.
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After the intense gyrations of the last few weeks, things have calmed down and traders have settled for another quarter-point Fed hike — a bet that has recently trumped the odds of a pause or even a bigger increase. While several market observers say a 50 basis-point boost would be a shock, many expect the central bank to raise its projections for rates this year in a bid to sound tough when it comes to the war against inflation.
“This period of calm will no doubt be welcomed by the Fed and allow for it to continue hiking by 25 basis points without much controversy,” said Craig Erlam at Oanda. “The question is whether it will adopt a similar position to its counterpart in Europe and refrain from commenting directly on future moves or sending any strong signals.”
Read: Fed Caught Between Inflation and Bank Crisis: Decision-Day Guide
With traders unwilling to make any big bets until they get more clarity from the central bank, the S&P 500 hovered near its 4,000 level. A gauge of US financial heavyweights halted a two-day rally amid news PacWest Bancorp is moving to shore up liquidity to protect itself after customers pulled 20% of their deposits since the start of the year.
Treasury two-year yields fell to around 4.1%, with the US dollar also losing ground. Bitcoin approached $29,000 for the first time since June.
Markets were pricing in about 85% odds that the Fed will raise rates by a quarter point Wednesday to a range of 4.75% to 5% — the highest since 2007 on the eve of the global financial crisis. The decision and forecasts will be released at 2 p.m. in Washington. Chair Jerome Powell will hold a press conference 30 minutes later.
To Dennis DeBusschere at 22V Research, the market reaction to the Fed could be “mixed or negligible,” but that would be because Powell manages to convey “very little” on the outlook for policy. And that would immediately put the focus on the May gathering, which would certainly hinge upon how data evolve and how obvious or not the overhang from the banking crisis becomes.
“Our hunch is still OK economic growth, and a Fed that could be raising rates again,” DeBusschere noted. “That will work against our cyclical call, but we will worry about that later.”
Stop Hiking?
Indeed, the question on whether the Fed will be done or not raising rates should be crucial in terms of shaping up the entire yield curve and the outlook for markets around the globe.
The central bank should stop hiking in the aftermath of a banking crisis that has contributed to tougher lending standards, according to Ed Yardeni, who coined terms like “Fed Model” and “bond vigilante.”
“We are just guessing, but financial conditions have surely tightened a lot as a result of the SVB earthquake and its aftershocks,” the president of Yardeni Research Inc. wrote in a note, referring to the failure of Silicon Valley Bank. “The banking crisis and the widening spread in the mortgage market suggest that Fed policymakers should pause tightening to avoid any further turmoil in the credit markets and even greater financial instability.”
The two-year Treasury yield crossed under the upper band of the targeted federal funds rate in December for the first time during this rate-hike cycle, with the spread deepening this month. This cross has had a stellar track record of leading to at least a pause from the central bank and has often pointed to cuts in the fed funds rate. In fact, the two-year yield crossed under the fed funds rate in advance of each rate-cut cycle that was affiliated with the past three recessions.
Since 1970
In most of the six instances since 1970 when the Fed raised borrowing costs by over 100 basis points for a period of a year or more and then paused hikes for at least three months, the pause was accompanied by a recovery in US stocks, with the S&P 500 returning 8.2% on average in those periods, according to Bloomberg Intelligence. During the entirety of the rate-hike pause, stocks averaged a return of 1.4% a month, above the overall average of nearly 1%.
“Whilst recent pressure on the banking sector is not evidence of systemic risk to the stability of the financial system, it may encourage the Fed to pause or end its cycle of tightening sooner than once expected,” said Richard Flynn, UK managing director at Charles Schwab. “In times of stress, concerns about financial stability often trump the Fed’s dual mandate. And with inflation easing somewhat, the Fed may feel it has more room to respond flexibly to recent events.”
Policymakers’ extraordinary actions to stem the fallout from banking stress may have sparked a “risk-on” rally, but we are sticking with our intermediate-term bearish base case, said Chris Senyek at Wolfe Research.
“Inflation is even more likely to remain ‘sticky,’ the Fed is likely to be much tighter than consensus expects, and we now expect the upcoming downturn to be even more protracted,” he added.
‘Robust’
Elsewhere, an unexpected surge in UK inflation has dashed any hope that the Bank of England is done with raising interest rates. Traders reacted by selling bonds, sending the yield on two-year gilts toward the biggest spike since September. Money markets fully priced in a quarter-point hike Thursday.
The European Central Bank will probably need to keep raising interest rates if markets stabilize, but officials need time to assess the full impact of recent turmoil, according to Governing Council member Pierre Wunsch. He spoke after ECB President Christine Lagarde pledged to take a “robust” approach that allows policymakers to respond to inflation risks as needed but also aid financial markets if threats emerge.
Officials last week raised rates by a half-point, defying turbulence to keep up the fight to restore price stability.
Key events this week:
Eurozone consumer confidence, Thursday
BOE interest rate decision, Thursday
Swiss National Bank rate decision and press conference, Thursday
US new home sales, initial jobless claims, Thursday
US Treasury Secretary Janet Yellen testifies to a House Appropriations subcommittee, Thursday
Eurozone S&P Global Eurozone Manufacturing PMI, S&P Global Eurozone Services PMI, Friday
US durable goods, Friday
Some of the main moves in markets:
Stocks
The S&P 500 fell 0.1% as of 1:32 p.m. New York time
The Nasdaq 100 rose 0.3%
The Dow Jones Industrial Average fell 0.3%
The MSCI World index rose 0.3%
Currencies
The Bloomberg Dollar Spot Index fell 0.2%
The euro rose 0.2% to $1.0793
The British pound rose 0.2% to $1.2247
The Japanese yen was little changed at 132.56 per dollar
Cryptocurrencies
Bitcoin rose 1.2% to $28,492.3
Ether fell 0.7% to $1,788.98
Bonds
The yield on 10-year Treasuries declined six basis points to 3.55%
Germany’s 10-year yield advanced four basis points to 2.33%
Britain’s 10-year yield advanced eight basis points to 3.45%
Commodities
West Texas Intermediate crude rose 1.1% to $70.43 a barrel
Gold futures rose 0.5% to $1,968.80 an ounce
This story was produced with the assistance of Bloomberg Automation.
--With assistance from Peyton Forte, Carly Wanna, Angel Adegbesan and Isabelle Lee.
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