U.S. stocks rallied into the close as traders wagered the worst of the banking turmoil has passed. Treasuries fell.

The S&P 500 recovered much of its lost gains in the late afternoon after a Russian fighter jet collided with a U.S. drone tamped down the initial enthusiasm. Remarks from ratings companies on the financial sector underscored the fragile sentiment as markets were jolted by the biggest American bank failures since the financial crisis.  The dollar slumped.

The relief rally in banking stocks was crimped as the KBW Bank Index ended the day with a 3.2 per cent gain after First Republic Bank triggered a volatility halt following S&P Global Ratings placing the company on watch negative. Moody’s Investors Service cuts its outlook on the sector on the heels of the trio of banking collapses over the past few days. 

The two-year Treasury yield climbed to 4.2 per cent— following a three-day swoon that was the biggest in decades amid the tumult — after data showed inflation remained elevated in February. Swaps traders now expect the Fed to lift rates by a quarter percentage point. Odds of an increase had slipped to nearly 50-50 on Monday. 

“The market is indecisive right now. It’s completely undecided on which way we’re supposed to go,” said Liz Young, head of investment strategy at SoFi. “At the end of yesterday it tried to price in what it thought CPI was gonna do and then CPI came in. It’s like we’re not sure what’s good and what’s bad anymore. And we’re stuck in this purgatory.”

U.S. consumer prices rose 0.4 per cent in February, meeting economists’ forecast. The closely watched core CPI number — which excludes food and energy — increased 0.5 per cent, just ahead of the median estimate of 0.4 per cent.

Anxiety on an expanding bank contagion was more subdued on Tuesday as the Cboe Volatility Index or the VIX, fell as much as 16 per cent, the most since December 2021. The fear-gauge had topped 30 for the first time this year on Monday. Trading volume was also reined in, pulling back from the previous day’s year-to-date high.

Treasuries have been whipsawed in recent days — with a measure of volatility climbing to the highest since 2009 — and banking shares plunged as the collapse of Silicon Valley Bank and two other U.S. lenders prompted wagers the Federal Reserve will pause its hiking cycle and even cut interest rates to stabilize the financial system. 

Tom Essaye, a former Merrill Lynch trader who founded “The Sevens Report” newsletter, expects that the data will keep the Fed on track to raise rates 25 basis points next week.

“Given the bank troubles, this report isn’t bad enough to put 50 bps back on the table, but if the Fed wants to maintain credibility on inflation, then this report says they have to hike again next week and not signal they are done,” Essaye wrote.

Goldman Sachs Group Inc. economists as well as asset managers from the world’s largest actively managed bond fund, Pacific Investment Management Co., said the Fed could take a breather on the policy rate following the collapse of SVB. Nomura Holdings Inc. economists took it one step further, saying the Fed could cut its target rate next week.

“Overall, this is an inflation update that, taken as a sole input, would suggest that a 25 bp hike next week is a foregone conclusion,” said Ian Lyngen, rates strategist at BMO Capital Markets. “Alas, the regional banking stress leaves next week’s decision as a wild card until there is greater clarity on the success of limiting the contagion to the rest of the banking sector from SVB/Signature.”

Elsewhere in markets, oil extended declines. Bitcoin topped US$26,000 for the first time since June. Gold slid after rising in the three previous sessions as traders turned to haven assets.

Here’s what else Wall Street is saying:

“Although the number was higher in core MoM than expected, it is probably not sufficiently so to corner the Fed into hawkishness at the next meeting. Therefore risk assets are able to breathe a sigh of relief here, as the Fed probably has the option to go easy at the next meeting, if they feel the banking system requires it.”

— Peter Chatwell, head of global macro strategies trading at Mizuho International

“The CPI number is no game changer. After the events last week, a 50bps appeared unlikely going into the data print today and the slightly stronger than expected core inflation print puts speculation of a Fed pause to a rest.”

“The Fed is on track for another 25bps hike next week. Equities should rebound somewhat as the Fed becomes more predictable for now. But the impact from higher rates on the economy is just starting to be felt and will likely become more and more visible as the year moves on.”

— Wolf von Rotberg, equity strategist at Bank J. Safra Sarasin

“Policymakers may still feel forced to press pause on rates, despite evidence the hot inflation is still a risk, unwilling to be blamed for making a bad situation worse. While smaller banks remain under pressure, there are concerns that bigger banks could become more risk averse in lending, which could dip the economy into a sharper downturn.

— Susannah Streeter, head of money and markets at Hargreaves Lansdown

“Equity markets are still priced for a rosy future which looks increasingly fanciful with each passing day. I’m sure the lack of further selloff in the rates markets today will comfort some but the reality is that treasuries can sense what equities are blissfully or willfully ignoring – this sort of monetary tightening from such an extreme starting position is unequivocal bad news for a fragile and highly levered system.”

— James Athey, investment director at Abrdn

“Every 24 hour period that passes where nothing else goes wrong, for the time being, maybe for the next week or so, is going to be encouraging and probably contributing to an upswing in equity prices across the board. But that doesn’t mean we’re going to leave this crisis, assuming that we’ve seen the worst of it, without any impairment at all.” 

“It’s a go-ahead for 25 basis points.”

— Brian Nick, chief investment strategist at Nuveen

“Continued hawkishness should still be warranted, or at least that’s what the Fed will likely want to state.  It puts the Fed in a tight spot. Higher interest rates amid banking turmoil might not be what investors want to see. However, a pause in a 0.25 per cent hike next week only delays the inevitable.”  

— Charles Hepworth, investment director at GAM Investments

Key events this week:

• China retail sales, industrial production, medium-term lending, surveyed jobless rate, Wednesday
• Eurozone industrial production, Wednesday
• U.S. business inventories, retail sales, PPI, empire manufacturing, Wednesday
• Eurozone rate decision, Thursday
• U.S. housing starts, initial jobless claims, Thursday
• Janet Yellen appears before the Senate Finance Committee, Thursday
• U.S. University of Michigan consumer sentiment, industrial production, Conference Board leading index, Friday

Some of the main moves in markets:

Stocks

• The S&P 500 rose 1.7 per cent as of 4:01 p.m. New York time
• The Nasdaq 100 rose 2.3 per cent
• The Dow Jones Industrial Average rose 1.1 per cent
• The MSCI World index rose 0.9 per cent

Currencies

• The Bloomberg Dollar Spot Index fell 0.1 per cent
• The euro was little changed at US$1.0741
• The British pound was little changed at US$1.2178
• The Japanese yen fell 0.7 per cent to 134.15 per dollar

Cryptocurrencies

• Bitcoin rose 3.4 per cent to US$25,052.27
• Ether rose 3 per cent to US$1,722.92

Bonds

• The yield on 10-year Treasuries advanced nine basis points to 3.66 per cent
• Germany’s 10-year yield advanced 16 basis points to 2.42 per cent
• Britain’s 10-year yield advanced 12 basis points to 3.49 per cent

Commodities

• West Texas Intermediate crude fell 4.3 per cent to US$71.56 a barrel
• Gold futures fell 0.4 per cent to US$1,908.50 an ounce