The second and third biggest bank failures in U.S. history could have been much worse for the market except for two things.
First, the federal government moved very quickly to guarantee deposits and indicated that it would do the same at other banks that also saw pressure. The factors that caused Silicon Valley Bank (SIVB) and Signature Bank (SBNY) to fail were fairly unique, and there isn't any major counter-party risk, so it is much easier to control the fallout than the situation that arose in the 2008-2009 financial crisis. Banks still face some substantial financial pressures as they adjust to this sudden shift in business conditions, but few are in danger of going under.
Second, the bank crisis has had a substantial impact on the trajectory of interest rates. Bond yields of all durations fell sharply, and it is now expected that the Fed's terminal interest rate will be much lower than expected.
Lower interest rates immediately cure some of the balance sheet issues faced by banks, but the problem of inflation and a potential recession is not going to go away.
The market will receive some additional insight into how inflation is progressing Tuesday morning when the CPI report is issued at 8.30 a.m. It is expected that CPI rose 0.4% in February, which would be an annual rate of 6%. That compares to 0.5% and 6.4% in January. While the market would be pleased to see some slowing, it is still running very hot and is nowhere close to what the Fed wants to see.
If the CPI report comes in a little cooler than expected, that will take some pressure off the Fed and allow them to pause as the banking crisis is sorted out, but if the numbers come in hot, it presents a real dilemma as the Fed has made it very clear that it is determined to drive inflation down even if it does cause higher unemployment and an economic slowdown.
The more important issue for traders is determining to what degree market participants will celebrate a less hawkish Fed. This is not as simple as dovish being good and hawkish being bad. If the Fed is willing to be less aggressive in its fight against inflation, it is because they are concerned that there are other issues that are a real danger to the economy.
Yesterday, Mike Wilson of Morgan Stanley suggested that the next leg of the bear market has begun and that any strength created by government intervention in the banking crisis should be sold. Wilson has been a bear all year and was very wrong back in January, but he has not changed his thesis that the market has failed to reflect how much earnings and growth are going to drop as the Fed's interest rate hikes take hold.
We have now seen how higher rates have hurt the entire banking sector, so it seems logical that there will be fallout in other areas of the market as well. That is the essence of Wilson's argument, and I will be watching to see to what degree the market embraces it.
The market will celebrate a cool CPI number, but if there is a spike on the news, then we need to watch closely to see how many folks are looking for exit points into strength. If the market is hit on a hot CPI number, will there be dip buyers ready to step up?
