As concerns about the impact of the Federal Reserve’s tightening on the economy continue to grow, investors are bracing for more banking sector turmoil in the US stock market.
This comes after two US lenders collapsed and Credit Suisse was taken over by rival UBS following the Swiss government’s intervention.
Financial stocks have been volatile throughout the week, and there are worries that there may be other unpleasant surprises in the banking sector, given the rapid series of interest rate hikes the Fed has delivered over the past year.
Many investors fear that cheap money will dry up, and fissures in the economy will widen. The collapse of Deutsche Bank’s shares this month, along with the rising cost of protecting against a default on its bonds, has also heightened concerns about the banking sector.
Despite this, few investors believe that this year’s events will result in a repeat of the 2008 systemic crisis that led to the downfall of Lehman Brothers and prompted government bailouts.
However, investors are wary of another bank run if people believe that US or European regulators will not step in to shield deposits.
The growing divergence between the Fed fund’s rate and the far lower interest rate on checking accounts is increasing the risk of bank deposit outflows, according to Apollo Global Management Chief Economist Torsten Slok.
Deposits at small US banks dropped by a record amount following the collapse of Silicon Valley Bank on March 10, and Federal Reserve emergency lending to banks remained high in the latest week, amid ongoing anxiety.
Investors have been piling into the safe haven of US Treasuries over the past week, sending yields on the two-year note to 3.76%, the lowest since mid-September.
The uncertainty over the Fed’s intentions is amplifying investor hesitation in stocks and sparking huge swings in US government bond prices, after policymakers indicated they were on the verge of pausing further increases as banking sector worries risk tightening economic conditions.
There are concerns that further banking industry failures could lead to rate cuts sooner, allowing the Fed to ease up on its fight against inflation.
Falling interest rates would make dividend-paying stocks and some riskier assets such as higher-quality below-investment-grade bonds attractive.
Despite concerns in the banking sector, risk assets have been somewhat resilient, and the S&P 500 is up 3.4% this year, although it is far off its early February highs.
Many investors seem to be giving stocks the cold shoulder, and allocations to US equities fell to an 18-year low, while cash allocations crept higher in March.
Investors will likely remain steeled for another potential high-profile failure until the Fed or Treasury responds in a way that calms fears of another bank run.