What the Fed’s Balancing Act Means for the Market

What the Fed’s Balancing Act Means for the Market

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The Fed raised the overnight rate by .25% today to 4.75-5.00%. This hike was less than traders had expected a few weeks ago but aligns with the consensus after the banking crisis kicked off last week.

The Fed is walking a very fine line right now. On one hand, inflation is still high, and the Fed believes the best way to fight that is by raising rates. However, we are now in an unexpected banking crisis that could get a lot worse if rates keep going up.

This balancing act is why the Fed only raised the overnight rate by .25% today rather than the .5% traders were pricing in before the regional bank collapse last week.

The Bank Crash Fallout

To put it in perspective, since the fall of Silicon Valley Bank (SIVB), the entire banking sector is still down 20%. This week we have a deal for UBS to acquire Credit Suisse Group AG (CS) at .025% of their post-financial crisis value. And let’s not forget that the Fed and the U.S. Treasury are stepping in to backstop several more regional banks in the U.S. that would otherwise be experiencing a run on their deposits, which would leave them with empty coffers.

The most common question we have received since SVB collapsed is whether we expect a repeat of the 2008 financial crisis. The collapse is alarming; however, there are some key differences with the 2008 crisis:

  1. The losses creating a crisis for banks like SVB are mostly associated with their Treasury holdings. In 2008, the losses were from toxic opaque derivatives and fraudulent bonds.
  2. New laws have given the Fed and Treasury a greater ability to intervene in failing banks. They don’t need to waste time getting buy-ins or waiting until it is too late.
  3. Most importantly, the scale of this crisis is much smaller and focused on “normal” banks rather than big investment banks like Lehman Brothers.

While we wait for the dust to settle, there are three takeaways from the current crisis.

  • The Fed is in a tough spot and will likely have to keep slowing its interest rate hike schedule. Maybe this will keep inflation high or maybe not, but it could boost tech and consumer stocks. The pressure on the Fed to slow down and support the economy is a positive takeaway from the crisis.
  • Banks are undervalued and we should take advantage of that soon, but we must be careful about the timing. In our experience, even good stocks get pulled down during a crisis, but they tend to form a basing pattern for a few weeks while regulators, investors, and analysts work to identify the true scale of the problem. We are probably still a month away from having a clear idea of how bad the issue is and where to find the best deals.
  • Longer-term interest rates are likely to keep rising. Regardless of what the Fed does with short-term rates, long-term interest rates probably going to go up as investors demand more return for taking risks in the form of loans. That is probably going to hit the real estate market and could slow consumer spending. The Fed mentioned the same issue in its statement today.

So far, long-term rates are still near the bottom of their recent channel. The yield on 10-year treasury bonds is just above 3.5% but has been rising higher over the past two days. If longer-term rates like the 10-year yield move beyond 4.5%, we would expect that to stop stocks from breaking out into a new bullish trend this spring.

Bottom Line

The banking crisis is an issue because it may drive long-term rates higher and will drag on investor sentiment. We don’t see this as a repeat of 2007-2008, but it could keep stock prices range bound through the spring and summer if rates hit new highs.

Besides the issues in the banking sector, other economic data remains positive. If nothing else changes, we would expect the market to remain above support.

The sectors to watch between now and the next Fed announcement include the usual favorites: consumer discretionary and select tech stocks, especially those in the explosive AI space.

Article printed from InvestorPlace Media, https://investorplace.com/tradingopportunities/2023/03/what-the-feds-balancing-act-means-for-the-market/.

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