Stocks are bouncing but market will soon face next big hurdle

Published Tue, Mar 14 20232:21 PM EDTUpdated Tue, Mar 14 20237:12 PM EDT

Patti Domm @in/patti-domm-9224884/@pattidomm

Stocks bounced back Tuesday, but volatility could remain high until investors become more confident about the future of the banking sector. Strategists see the Federal Reserve's policy meeting next Tuesday and Wednesday as the next big hurdle for markets, barring any other unexpected developments. Traders in the futures market upped their bets Tuesday to a more than 70% chance that the Fed raises interest rates by a quarter point on March 22. Regional bank stocks rose sharply Tuesday after being crushed on fears there could be more bank failures, following the rapid collapse of Silicon Valley Bank and Signature Bank. First Republic rose 27%, while PacWest ended Tuesday 34% higher. The SPDR S & P Regional Banks ETF rose 2%. FRC 1Y line bank The U.S. government Sunday approved plans to safeguard depositors and financial institutions affected by the collapse of SVB. Customers will have full access to their funds at SVB and also a t Signature Bank , shut by regulators on Sunday . "The volatility is so high right now. To say 'all clear' doesn't make much sense. What we're looking for is when, how and who is the first to tap the new Fed facility that allows them to pledge high quality securities and receive par value," said Julian Emanuel, head of equity, derivatives and quantitative research at Evercore ISI. Just as important "will be the market's reaction to when, who and how." Because developments around the banks remain cloudy, strategists say the stock market outlook is also more uncertain. Some now see higher odds of a recession, and that could create a rocky period for the market. Emanuel said there is a bigger chance for a recession now, and he also expects stocks could sell off and test lows. The S & P 500 hit a low of 3,491 on Oct. 13. It closed at 3,919, up about 1.7% Tuesday. .SPX 1Y line stocks "The patient has come out of intensive care [ with] extraordinary life-saving measures, but there is always a period of convalescence that tends to be longer and bumpier, made all the more so by the fact the Fed is likely to hike rates to fight inflation," said Emanuel. "They are likely to continue to try to conduct business as usual by hiking rates. That is likely to mean the stress in the financial system is not likely to dissipate overnight." The central bank will also release forecasts after that meeting, including new outlooks for interest rates and inflation. "Something pretty darn significant just broke as a result of higher rates," said Lori Calvasina, head U.S. equity strategist at RBC. "I think 50 [basis points] would get a negative reaction. I think the market would be fine with a pause and probably handle a 25 in stride, but it all comes down to the press conference and the details." A basis point equals 0.01 of a percentage point. Markets have been whipsawed in part because of Fed expectations. Only last Tuesday, Fed Chairman Jerome Powell told Congress that the Fed might have to raise interest rates more than anticipated because of persistently high inflation. That sent interest rates flying, and the 2-year Treasury yield jumped above 5%. But after it became clear later in the week that SVB was facing difficulties, yields plummeted as investors sought safety in bonds. By Monday, the 2-year yield declined more than 100 basis points in its biggest three-day move since the stock market crash of 1987. The 2-year yield is the most correlated to Fed policy, and it fell below 4% before rising to 4.24% late Tuesday. The S & P financial sector was up 2.2% Tuesday. But the market was led higher by the communications services, up 2.8%, and tech sectors, up 2.3%. "The focus should be how the financial stocks trade and how the 2-year yield moves," said Emanuel. "The longer that both of those are able to hold above their extremes of the last two or three days, the more healing can happen before the next risk event which is Wednesday's rate decision." Calvasina said stocks could continue to chop around, especially if investors are not confident in the outlook for banks. "I fear more that we're going to stay stuck in this rut longer than we would otherwise because of just what happened, rather than see a big drop," said Calvasina. "If this is contained and people are constantly worried about what is the next thing to break, that's an overhang for awhile." She said the market's behavior correlates to the post-tech bubble years of the early 2000s. She said 2022 and 2002 were similar years, and she said that could set up the market for another big downdraft, like the one in early 2003. That year the market made a low in March and bounced higher as the Iraq war got underway. Calvasina said the market could escape revisiting the lows but if a recession comes much later this year or even next year, the October lows have less chance of holding.