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U.S. Stocks In Turmoil As SVB Bank Failure Sparks Flight To Quality

U.S. stocks closed lower on Friday, 10th March 2023, closing its worst week so far this year after 4 days of losses.  

On the same day, Silicon Valley Bank (SVB), a tech-focused lender, was closed by federal regulators, marking the largest bank failure since 2008. As a result, U.S. treasuries and gold rallied due to a flight to quality, while regional bank stocks experienced a significant drop. 

The bank failure overshadowed the February jobs report which came in mixed. Although the headline payroll number was higher than expected, wage increases were lower than expected, at 0.2% instead of 0.3% and the unemployment rate was higher than the previous month. Overall, the payroll number was less inflationary than expected. 

However, the rally after the report was short-lived as fears of stress in the banking sector took hold and caused the risk off, flight to quality trade back on. 

Swap markets are now pricing a 25 basis points hike for the next meeting taking the 50-basis point hike off the table. They are also pricing a rate cut at the end of the year. 

For the week, the Dow Jones average fell 4.4%, the S&P 500 slipped 4.5%, and the Nasdaq Composite lost 4.7%. 

Here are the closing levels on Friday, 10th March 2023:

 Last Change %Change 
Dow Jones 31,909.64. -345.22. -1.07% 
S&P 500 3,861.59. -56.73. -1.45% 
Nasdaq Comp 11,138.89. -199.46. -1.76% 
U.S. 10Y 3.7%   
VIX 24.8 +2.19 +9.69% 

It was a tough week for the bulls.  

Looking back, it could have been worse. I suspect some bulls are still willing to hold on to the belief that the markets will rally. 

However, this is a risky call. If the failure of Silicon Valley Bank (SVB) is the start of underlying problems or stress in the banking sector, things could get bad for stocks. 

Furthermore, there were already reports of banks competing for deposits by offering attractive rates thus eating into profits. 

Are we going to see stress in other sectors? Will corporates start to feel the pain of the recent fed rate hikes? 

There may be some confusion as to the massive rally in treasuries, specifically the 2-year bond, as it has fallen from well above 5% to close on Friday at 4.59%. 

The yield implies that the Fed will take a step back after the next hike, indicating a lower terminal rate. 

So far, nobody is calling it an overreaction to a flight to quality, which typically happens when there is stress in financial markets. This case being the collapse of SVB and the potential contagion effect on other small/regional banks. This is why investors are buying treasuries even though they are overpriced just to play it safe. 

The upcoming CPI (Consumer Price Index) report will play a significant role in determining how the yields will respond. If the report shows a higher than anticipated figure, the yields will need to reprice to reflect a more hawkish Fed. 

However, there is an expectation that the Fed will need to respond by being less hawkish or even start being dovish if this banking stress gets worse. 

As for stocks, the S&P is close to giving up all its gains for 2023 but the Nasdaq is still up close to 8% YTD. The S&P will need to stay above the January low to prevent a possible meltdown. 

This commentary is written by James Gomes.
James has been in the finance industry for over 30 years and most recently worked for a large U.S. bank for more than 20 years.

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