(Bloomberg Thurs. May 4th, 2023) – A plunge in regional banks roiled trading desks around the globe, with brewing anxiety about the next financial shoe to drop making traders increase their bets on Federal Reserve interest-rate cuts.
The plunge in Western Alliance Bancorp and PacWest Bancorp that topped 60% at one point triggered multiple volatility halts. The rout engulfed several other lenders — big and small — with First Horizon Corp. down 34% after its merger with Toronto-Dominion Bank was scrapped. A US probe into Goldman Sachs Group Inc.’s role in Silicon Valley Bank’s deal also weighed on sentiment.
All 21 shares in the KBW Bank Index of financial heavyweights such as JPMorgan Chase & Co. and Bank of America Corp. retreated. The $2.5 billion SPDR S&P Regional Banking exchange-traded fund was on pace for its lowest since September 2020. The S&P 500 headed toward its fourth straight decline — the longest losing streak since February. The drop in equities sent the CBOE Volatility Index (VIX) above the key 20 mark.
That all shows how investor angst remains elevated after a string of bank failures and deposit outflows despite Fed Chair Jerome Powell’s assurance that authorities were closer to containing the crisis. Smaller lenders are under pressure after a year of rate hikes hammered the value of their bond holdings and drove unrealized losses to an estimated $1.84 trillion.
“The acute phase of bank turmoil may not be over, and policymakers need urgently to recognize that,” said Krishna Guha, vice chairman at Evercore ISI. “The problem is that their financial stability policy options are limited.”
Strategic Options
In such a stressful scenario, some lenders have been trying to assuage investors — with little to no avail.
PacWest Bancorp tumbled 45% even after saying core deposits have increased since March and confirming it’s in talks with several potential investors. Western Alliance also pared losses, but was down 29% despite its denial that the firm is exploring strategic options including a possible sale of all or part of its business.
“Obviously a rough day today — we’re having the latest flare-up in what is slowly becoming a crisis of confidence in the regional-banking sector here in the United States,” said Jim Smigiel, chief investment officer at SEI. “We have recommended additional cash allocations out of equities for our clients.”
That said, Smigiel and a myriad of market observers don’t see the parallels being made in what we’re going through today versus the 2008 financial crisis.
“Some of the differences are obvious — that was a credit crisis, this is not a credit crisis,” he noted. “This is more of an asset-ability-management issue and, of course, some of the ancillary effects of hiking interest rates 500 basis points in a very, very short period of time. But it doesn’t take away from the fact that this is the market testing the weakest hands in the sector and really continuing to do that as we’re seeing today.”
Lending Crunch
The recent collapse of First Republic Bank and a raging selloff in regional banks has also bolstered fears of a lending crunch that could spur a hard landing. For firms with shakier finances that often borrow money not only through banks but also with high-yield debt, signs of stress in the system may inflict even more pain.
“Companies with the highest level of leverage aren’t necessarily the most prudent ones, so if we see a pullback in bank lending, they become harder to underwrite,” said Max Gokhman, head of MosaiQ Investment Strategy at Franklin Templeton Investment Solutions. “Investors recognize that if rates go down, they may not necessarily go down for the most-indebted companies and they may have a hard time getting additional financing when they need it most.”
That’s a tricky scenario for a central bank that just raised rates to the highest level since 2007, signaled a potential pause as early as June, but refrained from hinting at a pivot at this stage.
The five-year Treasury note’s yield fell to the lowest level since August as traders ramped up bets on interest-rate cuts by the Fed during the second half of this year in response to the deepening rout in US regional bank shares.
July Fed Cut
Swaps linked to Fed meetings suggest that the central bank is likely to reverse by July the quarter-point increase it implemented at its meeting this week — and about a one-in-four chance that such a rate cut could happen as soon as June.
Traders are also gearing up for Friday’s key jobs report, following data that showed applications for US unemployment benefits rose by the most in six weeks while continuing claims fell. Even as the labor market starts showing some weakness, it’s still cooling at a much slower pace than other economic indicators in the wake of an aggressive tightening campaign by the Fed.
“In our view, the Fed is very unlikely to cut unless there’s severe financial stress and/or a recession is imminent — stocks likely go down in both scenarios,” said Chris Senyek at Wolfe Research.
Later in the day, traders will be sifting through Apple Inc.’s quarterly earnings. After blowout results from Microsoft Corp. and Meta Platforms Inc. spurred huge rallies in their stocks, there are concerns the bar has been set too high for the iPhone maker.
Not only does Apple trade at an elevated valuation to peers, but it also comes with a weaker growth outlook. Second-quarter results are expected to show a 4.8% drop in revenue and a 5.8% slide in earnings, according to consensus analyst estimates, paving the way for a first year of declining sales since 2019.
Posted by:
Jack Dempsey, President
401 Gold Consultants LLC
jdemp2003@gmail.com