A fresh rout in regional banks roiled trading desks around the globe, with brewing anxiety about the next financial shoe to drop making traders increase their bets on Federal Reserve interest-rate cuts. Apple Inc. climbed in late trading after revenue beat estimates.

Another unsettling round of trading halts in the financial industry hit Western Alliance Bancorp and PacWest Bancorp this time amid losses that topped 60 per cent for each stock. The rout engulfed several other lenders — big and small — with First Horizon Corp. down over 30 per cent after its merger with Toronto-Dominion Bank was scrapped. A probe into Goldman Sachs Group Inc.’s role in Silicon Valley Bank’s deal also weighed on sentiment.

All 21 shares in the KBW Bank Index of financial heavyweights such as JPMorgan Chase & Co. and Bank of America Corp. retreated. The US$2.5 billion SPDR S&P Regional Banking exchange-traded fund closed at the lowest since October 2020. The rout in banks kept a lid on the broader market, with the S&P 500 suffering its fourth straight decline. 

Wall Street’s fear gauge, the Cboe Volatility Index (VIX) spiked, reaching the key 20 mark. That’s a stark contrast with the calm that prevailed in markets for the most part in April and saw the measure below 16 just last week.

That also all shows how investor confidence remains fragile after a string of bank failures and despite Fed Chair Jerome Powell’s Wednesday assurance that authorities were closer to containing the crisis. Smaller lenders are under pressure after a year of rate hikes hammered the value of their bond holdings and drove unrealized losses to an estimated US$1.84 trillion.

“The acute phase of bank turmoil may not be over, and policymakers need urgently to recognize that,” said Krishna Guha, vice chairman at Evercore ISI. “The problem is that their financial stability policy options are limited.”

STRATEGIC OPTIONS

In such a stressful scenario, some lenders have been trying to assuage investors — with little to no avail.

PacWest Bancorp tumbled 51 per cent even after saying core deposits have increased since March and confirming it’s in talks with several potential investors. Western Alliance also pared losses, but was down 39 per cent despite its denial that the firm is exploring strategic options including a possible sale of all or part of its business.

“Obviously a rough day today — we’re having the latest flare-up in what is slowly becoming a crisis of confidence in the regional-banking sector here in the United States,” said Jim Smigiel, chief investment officer at SEI. “We have recommended additional cash allocations out of equities for our clients.”

That said, Smigiel and a myriad of market observers don’t see the parallels being made in what we’re going through today versus the 2008 financial crisis.

“It’s not a credit crisis, it’s an interest-rate issue,” he noted. “This is just rates have gone up so quickly the valuation of their asset book has declined.”

The recent collapse of First Republic Bank and a raging selloff in regional banks has also bolstered fears of a lending crunch that could spur a hard landing. For firms with shakier finances that often borrow money not only through banks but also with high-yield debt, signs of stress in the system may inflict even more pain.

HARD TIME

“Companies with the highest level of leverage aren’t necessarily the most prudent ones, so if we see a pullback in bank lending, they become harder to underwrite,” said Max Gokhman, head of MosaiQ Investment Strategy at Franklin Templeton Investment Solutions. “Investors recognize that if rates go down, they may not necessarily go down for the most-indebted companies and they may have a hard time getting additional financing when they need it most.”

That’s a tricky scenario for a central bank that just raised rates to the highest level since 2007, signaled a potential pause as early as June, but refrained from hinting at a pivot at this stage.

Bond traders eyeing the deepening rout in U.S. regional bank shares concluded the Fed is likely to reverse this week’s quarter-point interest-rate increase by July in response to tightening credit conditions.

Swap contracts linked to Fed meeting dates collapsed, with the July rate briefly falling to 4.82 per cent, a quarter point below the 5.08 per cent level where the effective fed funds rate is likely to settle as a result of Wednesday’s increase in the target band to 5 per cent-5.25 per cent. The June swap rate at lows around 5 per cent reflected one-in-four odds of a cut as soon as June.

JOBS REPORT

Traders are also gearing up for Friday’s key jobs report, following data that showed applications for U.S. unemployment benefits rose by the most in six weeks while continuing claims fell. Even as the labor market starts showing some weakness, it’s still cooling at a much slower pace than other economic indicators in the wake of an aggressive tightening campaign by the Fed.

“In our view, the Fed is very unlikely to cut unless there’s severe financial stress and/or a recession is imminent — stocks likely go down in both scenarios,” said Chris Senyek at Wolfe Research.

Meantime, fears about a political standoff over the U.S. debt limit are driving up rates on short-term Treasury bills, pushing them over 10-year yields by the most in at least three decades. 

The risk that Congress will fail to act drove 3-month Treasury bill yields to over 5.25 per cent, with them hitting as much as about 2 full percentage points over 10-year yields on Thursday. That’s the most since the data compiled by Bloomberg began in 1992. 

Some of the main moves in markets:

Stocks

• The S&P 500 fell 0.7 per cent as of 4 p.m. New York time
• The Nasdaq 100 fell 0.4 per cent
• The Dow Jones Industrial Average fell 0.9 per cent
• The MSCI World index fell 0.5 per cent

Currencies

• The Bloomberg Dollar Spot Index fell 0.1 per cent
• The euro fell 0.4 per cent to US$1.1014
• The British pound was little changed at US$1.2574
• The Japanese yen rose 0.4 per cent to 134.15 per dollar

Cryptocurrencies

• Bitcoin rose 1.3 per cent to US$28,890.52
• Ether rose 0.1 per cent to US$1,876.22

Bonds

• The yield on 10-year Treasuries advanced three basis points to 3.36 per cent
• Germany’s 10-year yield declined six basis points to 2.19 per cent
• Britain’s 10-year yield declined four basis points to 3.65 per cent

Commodities

• West Texas Intermediate crude was little changed
• Gold futures rose 1 per cent to US$2,057.70 an ounce