The market narrative has been undergoing a substantial shift as a result of the crisis in the banking sector. The impact of the most aggressive rate hikes in history suddenly was felt when banks with substantial unrealized losses in their bond portfolios were hit with a liquidity crisis as deposit withdrawals suddenly accelerated.
Central banks and government officials worldwide sprang into action to shore up confidence in the financial sector and have done well so far. While two banks have been forced to liquidate, two others have been saved so far and there are plans to help other banks that may run into problems.
This crisis has caused a sharp shift in the trajectory of interest rates. Expectations for a rate hike at the Fed's meeting next week when from a nearly certain 50-basis-point increase to a bet there would be no hike at all; now were back to expectations of a 25-basis-point hike.
The economic bears are convinced the fallout from these events is far from over. They have increased their expectations that a recession is coming as lending standards tighten, and that seems to be confirmed in a rush to buy bonds. While there is still substantial worry about inflation, there is now much greater concern about economic growth.
Big-picture market strategists such as Mike Wilson of Morgan Stanley have been warning all year that economic slowing, estimate cuts and contracting valuation would cause the next leg of the bear market. That proved wildly wrong in January when the price action bulls took advantage of bears who were too aggressive in anticipating a rollover.
There are similar dynamics at work again as the economic bears are gaining confidence in their thesis due to the banking crisis. While the market is relieved that the problems have been contained so far, there is still quite a bit of nervousness about how things will unfold as the Fed continues its battle against inflation and the economy continues to deteriorate.
The bulls are aware of the economic arguments, but they are focused on price action. Every time there is a bounce, the narrative takes hold that the problems are already fully discounted. That may be nonsense, but it produces short-squeeze and FOMO action, and the bullish view is reinforced by positive technical action.
That is where things stand on Friday morning.
There are no major news events on the agenda today and the market is fairly confident that the Fed will hike rates by one-quarter percentage point next Wednesday, so the primary focus will remain on the price action. There is potential for more squeeze action and there will likely be short-term dip buyers after the big positive move on Thursday.
The economic bears may have better arguments, but in the short term, the price action bears have more momentum. The key right now is to be aware of your time frames and be ready for volatility as more news flow drives the action.