Wall Street’s favorite volatility gauge tumbled as a rebound in stocks deepened, with a surge in banks and assurances from authorities easing concern the recent financial tumult would lead to a full-blown crisis.
Call it calm. Or call it calm before the storm.
Whatever the case, the coordinated actions to resolve the banking turmoil have restored a semblance of order for now. The market’s so-called fear barometer, or VIX, saw its biggest two-day plunge since May. In the run-up to the Federal Reserve decision, traders are betting on another 25 basis-point hike, with officials forging ahead with their battle against inflation and signaling commitment to financial stability.
“This is an easier market backdrop,” said Nicholas Colas, co-founder of DataTrek Research. “Expectations of a dramatic about-face for monetary policy are diminishing. Market expectations for near-term Fed rate decisions are now within the realm of the possible. That is good news.”
Expectations for rate hikes have declined over the last two weeks amid the collapse of three US regional banks and the takeover of Switzerland’s Credit Suisse Group AG. Still, uncertainty over the Fed decision is among the highest since the pandemic sparked emergency rate cuts in 2020. Another important element of this week’s meeting: Policymakers are set to issue updated rate projections for the first time since December, offering guidance on whether they still expect any additional hikes this year.
The S&P 500 topped 4,000, extending its advance above the key 200-day moving average. After briefly exceeding 30 last week for the first time since October, the Cboe Volatility Index plummeted to around 21. Every stock in a measure of US financial heavyweights climbed. First Republic Bank surged almost 30% – its best day ever – amid optimism over a new plan under discussion to aid the regional lender.
Not Too Fast
Now the rally in the riskier corners of the market doesn’t mean an all-clear at this stage.
To Matt Maley at Miller Tabak + Co., investors should be careful about the conclusions they draw from the recent equity advance as there are at least two ways to look at it.
“One is to think that the stock market is looking past this mini-crisis and sees that the economy (and thus earnings) are going to grow quite nicely once we get past this problem,” Maley said. “The other way to look at it is to think that the situation is still quite a dicey one, and the authorities are pumping so much short-term liquidity into the system that the stock market cannot decline over the near term.”
Several strategists are indeed growing concerned, with Morgan Stanley’s Michael Wilson saying the risk of a credit crunch is increasing materially. The S&P 500 might find a floor at 3,800, but investors should sell into any rallies if the benchmark reaches 4,100 to 4,200, Bank of America Corp.’s Michael Hartnett wrote.
BofA’s latest global survey of fund managers showed a systemic credit event has replaced stubborn inflation as the key risk to markets. The polling took place from March 10-16, while money managers were witnessing the collapse of US lenders Silicon Valley Bank and Signature Bank and monitoring the turmoil at Credit Suisse before its historic takeover by UBS Group AG. The likelihood of a recession is rising again for the first time since November, with the survey showing a net 42% of participants expecting a slowdown over the next 12 months.
‘Like a Meme Stock’
Another worrisome development is the extreme volatility in short-term government bonds that has now dragged into a ninth straight day. The Treasury two-year note, which is normally considered a low-risk investment, saw its yield surge as much as 21 basis points to 4.18% Tuesday.
John Hancock Investment Management’s Matthew Miskin is certain the Fed has run out of runway for a soft landing, and he’s pointing to turbulence in the bond market to make that case.
“When the two-year Treasury yield starts acting like a meme stock, you’ve got some problems,” Miskin told Bloomberg Television. “The bond market is saying, ‘yeah, you’re going to raise rates but it’s going to be a mistake and you’re going to be cutting in the not so distant future.’”
On the eve of the Fed rate announcement, companies piled into the US investment-grade bond market. Nine borrowers, mostly utilities, raised fresh debt following a six-day rout that came to an end on Monday. Among the names were insurance provider MetLife Inc., which sold a $1 billion 10-year note that yields 1.58 percentage point over Treasuries, after initial price talks of 1.85 percentage point, according to a person familiar with the matter.