NEW YORK, March 10 (Reuters) – A critical inflation report next week will test a U.S. stock market already consumed by concerns over Federal Reserve hawkishness and potential fallout from the biggest banking crash since the financial crisis.
Friday’s mixed U.S. jobs report eased some worries about big rate hikes, days after Fed Chairman Jerome Powell warned that policymakers may raise rates higher than expected if upcoming data show the economy remains warm after nearly a year of tightening.
However, a warmer-than-expected consumer price report on Tuesday could reignite fears of jumbo-sized Fed rate hikes like the ones that rocked markets last year. That would be unwelcome in a market reeling from this week’s failure of SVB Financial Group ( SIVB.O ), which does business as Silicon Valley Bank.
“There’s uncertainty around the inflation report and there’s a lot of confusion caused by the SVB failure and concern that it could be a bigger problem,” said Robert Pavlik, senior portfolio manager at Dakota Wealth. “The market is dealing with confusion and uncertainty in a very short time frame.”
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The S&P 500 sank on Friday, bringing the weekly loss to 4.5%. After a big rally in January, the benchmark index is now sticking to a 0.6% gain for 2023.
Investors are getting nervous that the Fed’s campaign to fight inflation by ending the era of cheap money has exposed cracks in the economy that could widen if it ratchets up its rate hikes.
Traders were alert for signs of contagion in the financial sector and beyond in the wake of problems for SVB and crypto-focused Silvergate ( SI.N ), which this week revealed plans to wind down operations and voluntarily liquidate.
“The concerns from the financial sector are spilling over into the market in general,” said Michael James, managing director of equity trading at Wedbush Securities. “When you combine the collapse of Silvergate with the collapse of Silicon Valley Bank … it creates a ripple effect of concern for overall market stability.”
On Friday, markets appeared to be scaling back their expectations of Fed hawkishness, pricing in a 40% chance that the central bank will raise interest rates by 50 basis points at its meeting on the 21st-22nd. March, according to CME’s Fedwatch tool. Those odds were around 70% as recently as Thursday, but fell on Friday after investors saw employment data and gained more clarity on the extent of SVB’s problems.
Late Friday, yields on two-year U.S. Treasuries, which closely track the Fed’s policy expectations, were on track for their biggest two-day basis point drop since September 2008.
“The Fed now has very clear evidence that they are having an impact on the financial system and the economy — interest rate hikes are starting to bite — and while it’s not enough to give them pause, it’s something they will take into account,” he wrote. Mark Haefele, Chief Investment Officer at UBS Global Wealth Management in a Friday report.
Interest rate expectations could again change dramatically if the February CPI report comes in above the 6% year-on-year increase expected by analysts polled by Reuters. The consumer price report is followed the next day by more inflation data on producer prices.
While moderating annual inflation from a peak of 9% last year to current levels was the “easy move,” going from 6% to 3% will be more difficult, said John Lynch, chief investment officer of Comerica Wealth Management.
FOCUS ON INFLATION
Markets have been more volatile on average on CPI days over the past year, with the S&P 500 moving an average of 1.8% in both directions on those days versus an average move of 1.2% daily overall over that time frame .
Midday Friday, S&P 500 index options implied the CPI print would move the index 1.8% in either direction in the hour following the data release, according to Optiver data.
Volatility rose on Friday, with the Cboe Volatility Index, known as Wall Street’s fear gauge, hitting its highest level since late October amid a broad stock selloff.
In addition to signs of falling inflation, investors could be reassured if it became clearer that SVB’s issues were unlikely to spread.
“If banks say their financials are in good shape and they don’t see the same problems to that extent, then that will stabilize the market a little bit,” said James Ragan, director of wealth management research at DA Davidson.
Reporting by Lewis Krauskopf; additional reporting by Saqib Iqbal Ahmed, Sinéad Carew, Stephen Culp; Editing by Ira Iosebashvili and David Gregorio
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