Banking Sector Drama Continues, Stocks pare losses as rate cuts fully priced in

Investors try to shrug off banking drama

Wall Street was initially dragged down as banking worries persisted after Deutsche Bank’s costs against default skyrocketed. Deutsche Bank’s 5-year CDS surged from around 150 bps early on Thursday to a four-year high around 210 bps before settling closer to 193 bps.  Other European banks, Societe Generale, Credit Agricole and BNP Paribas declined on banking turmoil fears. Capital ratios in Europe are better there, but confidence with the US big banks is much higher. The large US banks are down modestly today.

The question that everyone was asking is whether there is a real problem with Deutsche Bank.  After traders took a closer look at Deutsche Bank, they realized that after restructuring, they have been profitable for 10 consecutive quarters. 

If confidence goes for a bank and they suffer a crippling bank run, we could see authorities pressured to act. Depending on the bank and contagion risk, we could see a rushed decision on what protections they can do for the banking sector as a whole.

US stocks pared earlier losses as both pressure builds for Treasury Secretary Yellen and financial regulators to tackle banking contagion risks and as Fed Fund futures grow confident that the next move will be a rate cut by the Fed. Fed’s Bullard’s hawkish comments reminded investors that if banking turmoil eases quickly, the Fed still could have a few more rate hikes in them.  

The morning saw better-than-expected flash PMI data, which suggests the economy remains resilient and a key inflation gauge fell to the lowest levels since 2021. The NY Fed inflation gauge for February fell from 5.10% to 4.75%.

This rush to pessimism over everything in finance might be overdone as some companies are well positioned to weather this storm.  Charles Schwab’s CEO told the WSJ that they could survive if most of their deposits left this year.  Good banks should survive this volatility, but developments over the next week will be key.  

Fed There is a lot of stress everywhere, including the Fed’s balance sheet. The Fed’s balance sheet rose by $94 billion and is now up to$400 billion in two weeks. Banking turmoil is doing the Fed’s work and this wave of tightening of conditions will start to weigh on small business.  The economy is about to start weakening quickly and this is why Fed fund futures have low odds for the Fed to hike at the May 3rd meeting, but have rate cut odds as a coin flip for the June 14th meeting.