In what may be a preview of next week\u2019s Federal Reserve meeting, the European Central Bank has stuck by its inflation fighting guns by hiking its key interest rate 50 basis points this morning, despite growing fears about banking stability and various indicators depicting disinflation in the U.S.<\/p>\n\n\n\n
Shares of troubled Credit Suisse reversed a dramatic decline this morning after the bank announced it had secured a $54 billion loan from the Swiss National Bank. The rally was short-lived, with the banks\u2019 shares subsequently dropping more than 20%. While Credit Suisse has struggled with financial losses and a surge in customers withdrawing assets, its more recent troubles started when its largest shareholder, Saudi National Bank, said it won\u2019t pump more into the Swiss institution. Fears of U.S. banking instability are also continuing following the failures of SVB Bank and Signature Bank, with shares of First Republic Bank declining significantly yesterday and today after plunging 62% on Monday and then rallying on Tuesday. <\/p>\n\n\n\n
Markets, however, are cheering the government interventions of the U.S. and the Swiss government to assist their respective banks and depositors for now, with the S&P 500 Index rallying 1% and nearing its pivotal 200-day moving average at 3938. Tuesday\u2019s rally failed right around that point and traders will be watching to see if breadth, momentum buying and 0DTE activity can launch the index above that level. The rate-sensitive NASDAQ is rip roaring higher, up 1.6% and helping to crush volatility as traders unwind hedges and the Volatility Index (VIX) is down 2 points or 7.5% to 24.24. The short-end of the yield curve is higher this morning as the ECB sets a potential precedent for Powell to go at least 25 basis points (bps) next week while the long-end of the yield curve and the Dollar Index are down modestly. Crude oil sank further in the early morning but is now roughly unchanged at $67.50 per barrel. <\/p>\n\n\n\n
Investors have been watching to see what part of the economy breaks under the stress of tightened monetary policy as central banks take aggressive actions to fight inflation. Many investors have hoped the economic distress, such as banking problems, would cause central banks to become less hawkish. Throw into the mix yesterday\u2019s U.S. reports of declining consumer spending and disinflation for supplier prices, according to the Producer Price Index, and the combined result caused investors to become increasingly optimistic that central banks would back off their inflation battle. During its meeting this morning, however, the ECB raised its deposit rate 50 bps, bringing the rate to 3% but it also reduced its inflation forecast. In December, it forecasted that headline inflation and core inflation this year would hit 6.3% and 5.3%, respectively, but during its meeting today it lowered those numbers to 4.2% and 4.6%. The ECB rate hike, however, has resulted in investors lowering their expectations for the ECB\u2019s terminal rate from 4.2% last week to 3.2% today.<\/p>\n\n\n\n
Market participants are now turning their attention to the tight U.S. labor market and next week\u2019s meetings of the Fed and the Bank of England. Last week, inflation-weary investors welcomed news that U.S. labor conditions may be easing with initial jobless claims increasing by 22,000 during the week ended March 3, but the optimism was short-lived with the Labor Department reporting this morning that initial jobless claims declined by 20,000 last week. Also released this morning, building permits and housing starts reaccelerated in February, coming in above expectations, as lower relative rates propelled activity in the real estate sector. Powell and central bankers alike need to thread the needle with prowess as they manage their priorities of inflation and financial stability, because since the middle of 2022, any relief on the interest rate front has led to a short-term boost in economic activity and as a result, more inflation.<\/p>\n\n\n\n
Inflation hawks who believe regulators have thwarted a wide-spread contagion of bank instability following the failures of SVB Bank and Signature Bank maintain that the Fed needs to remain aggressive and hike the fed funds rate 50 bps. They point to Fed Chairman Jerome Powell\u2019s earlier comments that the central bank is open to increasing the intensity of its rate hikes if inflation persists. At the moment however, odds of 82% significantly favor a 25bp hike at next week\u2019s meeting.<\/p>\n\n\n\n
In the UK, meanwhile, the Bank of England continues to fight inflation while facing the headwinds of a new round of fiscal stimulus with Chancellor of the Exchequer Jeremy Hunt unveiling the equivalent of $27 billion a year in spending, including free childcare support, new business investment incentives and extra military spending. Bank of England policy makers therefore must assess the impact of fiscal stimulus on inflation and whether raising interest to destroy demand and dampen price increases will worsen banking instability.<\/p>\n\n\n\n