Federal Reserve Rate-Hike Odds Dive As Latest Bank Fix Has Holes; S&P 500 Falls

A US Federal Reserve rate hike next week looks much less likely as bank stocks and the broader S&P 500 resumed their decline on Friday after a day’s respite. Even stocks of Bank of the First Republic (FRC) tumbled as optimism quickly faded after Thursday’s $30 billion bailout boosted confidence.


The Fed and other regulators pulled several bazookas last weekend to contain an emerging banking crisis, but fell short. Then the country’s largest banks tried to ride to the rescue. Bank of America (BAK), Citigroup (c), JPMorgan Chase (JPM) and Wells Fargo (WFC) each contributed $5 billion to First Republic, and six other banks combined added $10 billion. That should end a panic that caused customers to withdraw more than $250,000 in uninsured deposits.

$30 billion slows down the banking crisis for a day

On Wednesday, S&P Global and Fitch Ratings downgraded their credit rating on First Republic to “junk” status with potential for further downgrades. Both cited an increased risk of deposit outflows following the collapse of SVB Financial Group and Signature Bank. Fitch noted that the high concentration of affluent and financially sophisticated customers in coastal markets leaves First Republic with an unusually high proportion of uninsured deposits “which may be less sticky in times of crisis or severe stress.”

After a report that First Republic was considering a possible sale, FRC shares fell further Thursday morning – before rescue workers from the big banks arrived. But the fire hose of big bank money failed to dispel some serious doubts.

In a note on Friday, Wedbush analyst David Chiaverini lowered his target price on FRC shares to 5 from 140. With a potential “distressed M&A sale” on the table, Chiaverini said holders of common shares may be left with nothing.

FRC stock was down 33% on Friday. PacWest Bancorp (PACW) was another big loser, falling 19%. Even large bank stocks came under pressure. JPM shares and Wells Fargo both fell nearly 4%.

Banking crisis may worsen

There clearly appear to be some gaps in the bank bailouts implemented so far. Will banks other than First Republic, which have seen deposit outflows, receive their own cash injections from big banks?

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The continued decline in community and regional bank shares is hardly a sign of bank stability and may encourage uninsured depositors to turn to the most stable institutions.

On Tuesday, Moody’s lowered its outlook for the entire US banking sector. The rating agency expects banks to raise deposit rates to avoid outflows, which will negatively impact profitability.

Meanwhile, loan defaults are expected to rise as the economy weakens amid high interest rates. Banks are also expected to suffer losses on commercial real estate loans as office buildings are already grappling with high vacancy rates as more work is done from home.

In other words, the cracks in the ice remain, and there’s a good chance they’ll get bigger.

Even before the SVB crash, the Fed’s credit survey showed tighter credit conditions in late January. That should contribute to slower growth and lower inflation going forward.

As it stands, the Fed will need to be extremely cautious to avoid a deeper banking crisis, and a sensible first step would be to stop raising interest rates.

Federal Reserve rate hike rates

As of Friday afternoon, the probability of a Fed rate hike by a quarter point next Wednesday fell to 63% from around 80% the day before. Meanwhile, the odds of a subsequent rate hike on May 3 have fallen by more than half from the day before and now stand at around 25%.

Now Wall Street sees Fed rate cuts starting in July, if not sooner. By the end of the year, markets expect the federal funds rate to fall below 4%.

The banking crisis has clearly turned the Fed’s plan to keep interest rates high for longer on its head.

Up until last week, Fed officials were adamant that the cost of hiking too little easily outweighs the cost of hiking too much. The Fed assumed it could always cut rates to revive the economy if excessive tightening was to trigger a downturn. But with sudden evidence of the fragility of the banking sector, the risks now look more balanced or may even have flipped the other way.

Fed policymakers are likely still undecided on whether to push through another rate hike next week, Ian Shepherdson, chief economist at Pantheon Macroeconomics, wrote on Wednesday, a day after stronger-than-expected CPI inflation data.

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“In our view, it is more important not to risk the stability of the system than to reaffirm its determination to fight inflation,” Shepherdson wrote.

He expects the decision will depend on whether financial markets remain volatile, which could depend on officials having another trick up their sleeves.

S&P 500 rallies, Treasury yields rise

The S&P 500 fell 1.1% in Friday’s trading session. The S&P 500 slipped back below its 200-day moving average on Friday after reclaiming it with a 1.8% gain on Thursday.

Meanwhile, the 10-year government bond yield slipped 17 basis points to 3.41%, near a six-month low.

As of Thursday, the S&P 500 was up 10.7% from its bear market closing low on Oct. 12, but remained 17.4% below its record closing high in January 2022.

Be sure to read IBD’s The Big Picture every day to keep up to date with the underlying trend of the market and what it means to your trading decisions.

Fed, FDIC banking fix

The Fed, FDIC and Treasury Department last weekend attempted to boost confidence in the face of the collapse of SVB and Signature Bank by announcing that customers with uninsured deposits over $250,000 would not lose a dime. This prevented a possible full-blown national banking panic.

At the same time, the Fed announced a year-long bank financing program to address a key issue that had been plaguing the SVB. Faced with deposit outflows, the SVB had to redeem billions in low-yield government-backed mortgage securities that had fallen in value as interest rates soared over the past year. That left a big hole in the balance sheet.

Under the new Fed program, banks can pledge their fallen Treasuries and mortgage securities as collateral for low-cost Fed loans based on their initial or face value. This allows banks to avoid selling at large losses when they need cash and instead hold the bonds to maturity. JPMorgan expects the Fed program to provide banks with $2 trillion in liquidity even if the biggest banks don’t tap into it.

However, these steps do not appear to have completely prevented a crisis of confidence among uninsured depositors. While banking regulators have invoked a systemic risk exemption to protect uninsured deposits at SVB and Signature, it’s not certain they will do so if the next bank goes bust – unless it’s a big bank , the collapse of which could bring down the entire banking sector.

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The government’s Embassy, ​​Sen. James Lankford, R-Okla., told Treasury Secretary Janet Yellen at a hearing Thursday, “You’re fully insured regardless of the amount if you’re in a big bank.” That has deposit outflows from community banks in Oklahoma encouraged, he said.

Time for universal deposit insurance?

The simple and effective way to avoid contagion risk and deposit flight to the largest banks would be for the FDIC to temporarily guarantee all uninsured deposits. Former FDIC Chair Sheila Bair backed such a move in a Reuters interview Thursday. She also said the Fed should “take a pause” on rate hikes.

However, blanket deposit insurance would require the FDIC and Treasury Department to seek congressional approval. Therein lies a potential problem. If Congress considers such a sweeping move but rejects it, it could shake confidence even further. It would be like a repeat of the failed First House vote in 2008 for the Troubled Asset Protection Program.

Republicans carried the ball for small and medium-sized banks in 2018, passing legislation that watered down the 2010 Dodd-Frank financial reform regulations. Former Rep. Barney Frank, D-Mass., who actually served on the board of the failed Signature Bank, said deregulation, while exempting most banks from Fed stress tests, did not open the door to the current problem at stake in the The focus is on fallen government bonds.

It’s not clear whether the House-led GOP would support comprehensive deposit insurance, especially if Democrats talk about tightening banking regulations. If members of Congress make such a move, it could take even more volatile stock market action to convince them.


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