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How are Fed hikes affecting the US and European banking sector?


Reports emerged on Wednesday in the US that regional bank PacWest Bancorp [NasdaqGS:PACW] was seeking a buyer or an injection of capital. The news sent shares of several regional lenders tumbling in after-market trading, led by a 52.5% plunge in PacWest stock and a 23% slump for Western Alliance [NYSE:WAL].

This came despite a statement from Western Alliance assuring investors it had not experienced unusual deposit outflows following the sale of collapsed lender First Republic Bank to JPMorgan Chase. The after-hours falls came on top of losses in regular trading, despite reassurances by US Federal Reserve Chair Jerome Powell – presenting the FOMC’s latest 25bps rate hike – that the country’s banking system remained resilient.

Rob Clarry, Investment Strategist at wealth manager Evelyn Partners, says the continuing banking turmoil exposes the risks of further tightening from the US Federal Reserve:

“Global investors do not seem to think the turmoil among small regional US banks represents a systemic risk, although some of the UK-listed banking blue-chips have shown weakness in recent weeks. But the risks in the US of overtightening monetary policy are becoming clear. The failure of Silicon Valley Bank and Signature Bank in March exposed fragilities in the US banking system, and the collapse of First Republic this week further exacerbated these concerns. In US trading this week we have seen new share price distress in the cases of regional banks PacWest and Western Alliance.”

Clarry said that in a roundabout way, these failures may also help the Fed: as lending standards tighten in response to these events this will reduce the availability of credit, which in turn lowers economic activity and inflation.

How will Fed hikes affect the banking sector?

The FOMC raised its upper bound interest rate by 25 bps to 5.25% this week, in line with market expectations inferred from the Fed Futures market, and the economic consensus as reported in Bloomberg’s survey. The increase in the Fed Funds rate leaves it consistent with the year-end peak implied by the Fed’s March projections.

“Markets are now anticipating the Fed will pause its interest rate hiking cycle,” said Clarry. “This was also signalled by the FOMC as it dropped the guidance that ‘some additional policy firming may be appropriate’.”

Sentiment towards the three main US indices, S&P 500, NASDAQ 100 and DOW, saw a market uptick on Tuesday perhaps reflecting retail investors’ hope that the bailout would draw a line under recent turmoil in the banking sector. Though by Wednesday, pessimism had returned, with S&P 500 and NASDAQ 100 dropping back down to a bearish 97 and 98 respectively, according to proprietary SERIX investor sentiment measures from Spectrum Markets.

By contrast, sentiment towards the Dow, which is less exposed to financial companies, strengthened further to reach 108 on Wednesday.

The picture for European indices was a little different, with sentiment towards the EUROSTOXX 50 plummeting to 30, likely driven by fears of contagion to European banks which are well represented in the index. Spain’s IBEX saw a similar, but less acute, drop on Tuesday, though both indices recovered on Wednesday. Germany’s DAX 40 and Italy’s FTSE MIB started the week well, but saw sentiment drop off on Wednesday.

“It’s been a bumpy ride for markets this week, and we continue to see retail investors responding rapidly to breaking news all over the world,” said Michael Hall, Head of Distribution at Spectrum Markets. “The divergent SERIX data suggests that one big question on investors’ minds is whether First Republic’s bailout represents the end of a troubling time for American banks or the start of a challenging chapter for their European counterparts. And alongside this, all eyes will be on the central bank announcements coming out this week and next for a hint of what’s to come,” says Michael Hall, Head of Distribution at Spectrum Markets.”

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This article does not constitute investment advice. Do your own research or consult a professional advisor.

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