Stocks close higher despite Fed rate hike, bank turmoil

This decade is strewn with examples of bright people who thought they built a better mouse trap that could consistently extract abnormal returns from the financial markets. Some succeed for a time. But while there may occasionally be misconfigurations among market prices that allow abnormal returns, they do not persist. – Alan Greenspan 

The Federal Open Market Committee (FOMC) raised the federal funds interest rate by 25 basis points (a basis point is one hundredth of one percent) as expected last week and the major stock averages took the news in stride with gains of more than 1%. It was the ninth interest rate hike since the Fed began raising rates in March 2022 and it increased the fed funds rate to a range of between 4.75% and 5%. Fed officials indicated that future rate increases are not assured and will depend on economic data as it is released. They also expressed caution about the recent banking crisis and suggested that interest rate hikes are nearing an end. In the Fed’s so-called dot plot, or its outlook for the path of interest rates, the terminal or peak federal funds rate remains at 5.1%, equivalent to a target range of between 5% and 5.25%. In his press conference after the meeting, Federal Reserve Chairman Jerome Powell commented that the U.S. banking system remains strong and stable but that recent developments are likely to result in tighter credit conditions. There was also positive and negative news about the banking sector last week. UBS agreed to buy its troubled rival Credit Suisse and JP Morgan was advising First Republic Bank on strategic alternatives, including raising capital and a possible sale. But in yet another sign of the incompetence of the Biden administration, Treasury Secretary Janet Yellen in congressional testimony said that U.S. regulators would protect depositors if more bank runs were to happen only to walk back those comments the next day when she said that not all depositors would be made whole in the event of a bank run. The stock market plunged as investors were more worried about a financial crisis than the Fed’s actions or the possibility of a recession. What the banking crisis has done is change market sentiment to believe that the Fed will be cutting interest rates before the end of the year. And the bond market seems to agree as the 2-year Treasury yield fell to 3.75% while the 10-year Treasury yield dropped to just 3.35%.

Last Week

Existing home sales in February recorded their first monthly gain in a year and their biggest increase since July 2020 as home prices were lower on a year-over-year comparison as higher mortgage rates have resulted in lowering home prices. New home sales in February also rose for the third straight month as buyers took advantage of falling mortgage rates. Durable goods orders in February fell more than expected but excluding often-volatile transportation orders, orders were unchanged. Business investment also increased for the second straight month, a positive sign. Weekly jobless claims totaled 191,000, below estimates of 198,000 and 1,000 less than in the previous week.

For the week, the Dow Jones Industrial Average rose 1.2% to close at 32,237 while the S&P 500 Index increased 1.4% to close at 3,970. The Nasdaq Composite Index gained 1.7% to close at 11,823.

This Week

The final estimate of fourth quarter GDP is expected to remain unchanged at a 2.7% annual rate of growth. The March consumer confidence index is expected to be slightly lower than in February but well off its lows last summer due to continued strength in the labor market. The February core personal consumption expenditures (PCE) index, the Fed’s preferred inflation gauge, is forecast to increase 4.7%, the same as in January.

Banking regulators are scheduled to appear before the House Financial Services Committee to discuss the collapse of Silicon Valley Bank and Signature Bank.

Among the most notable companies scheduled to report quarterly earnings this week are Carnival, Micron Technology, Walgreens Boots Alliance, Cintas, Paychex, BioNTech, McCormick and Lululemon Athletica.

Portfolio Strategy

Stock market volatility is likely to continue again this week from the fallout of the banking crisis and the effects of the Federal Reserve rate hike. In addition, investors will keep a close eye on the personal consumptions expenditures (PCE) index to be released on Friday to assess any improvement in inflation. Unfortunately, the data will not include the effects of all the banking turmoil that has occurred in March. The failure of two banks earlier this month and the fear of contagion has affected consumer confidence and will likely affect credit availability and business investment. These developments could serve to slow the economy and possibly hasten the arrival of a recession later this year. The significant drop in the 2-year and 10-year Treasury yields recently has been the result of investors seeking a safe haven amidst all of the uncertainty and a sign that the economy will be slowing. Fed Chairman Jerome Powell sought to assure the public that the banking system is safe and that the Fed has the tools in place to protect depositors. The Financial Stability Oversight Council also met last week and concluded that the U.S. banking system “remains sound and resilient”. European Central Bank (ECB) President Christine Lagarde also made reassuring comments that euro zone banks have strong capital and liquidity positions and that the ECB could provide liquidity if needed. While these comments should provide comfort to investors, the road ahead is still likely to be bumpy given the uncertainty and questions about the financial system and the effects on the economy and the markets.