Shares jump but investor fears about bank ‘whack-a-mole’ linger

The Fed began a two-day meeting earlier on Tuesday and, after a wild few sessions, investors are divided about whether the central bank will raise interest rates by 25 basis points on Wednesday, or skip a chance at raising borrowing costs this month.

“We expect a 25-basis-point rate hike,” economists at TD Securities said in a note. “Post-meeting communication is likely to emphasize that the Fed is not done yet in terms of tightening, with officials also flagging the more uncertain economic environment.”

The Dow Jones Industrial Average jumped 0.98%, the S&P 500 rallied 1.3% to finish at 4,002.87 points, and the Nasdaq Composite Index climbed 1.6%.

Shares of First Republic Bank, a top concern of U.S. investors, surged 29.5% on news that JPMorgan CEO Jamie Dimon is leading talks with other big banks on new steps to stabilise it, including through a possible investment.

Many investors had thought concerns about banking sector stability were a thing of the past after the 2008 crisis. But the collapse of two U.S. regional banks, plus the 11th-hour rescue of Credit Suisse, are forcing central bankers to prioritise fighting inflation alongside keeping money flowing through the financial system.

The jury is out on whether the Bank of England will hold fire when it meets this week, and the picture is not much clearer for the European Central Bank, which raised rates last week but left traders without much idea of what to expect next.

“It seems the penny is dropping, most central banks hiked interest rates too late and then raised rates too fast. And now the world is reeling with a banking crisis,” Saxo Bank strategist Jessica Amir said.

European banking stocks, which seem headed for their biggest monthly slide in three years, rose by 3.8% on Tuesday, helping lift the regional STOXX 600 index by 1.3%.

Analysts said the Swiss government-backed takeover of Credit Suisse by UBS helped soothe concerns over European financial stability, even though a wipeout of some Credit Suisse bondholders has sent shockwaves through bank debt markets.

In a nod to concerns that banks may not be out of the woods, U.S. Treasury Secretary Jane Yellen said on Tuesday that further U.S. government intervention was possible if another smaller bank experienced difficulties similar to those of other recently failed lenders.

Indeed, Bloomberg News reported on Monday that U.S officials were looking at ways to temporarily expand Federal Deposit Insurance Corp coverage to all deposits.

“While global regulators are acting with pace, this appears to be a game of whack-a-mole,'” bank analyst Jonathan Mott at Barrenjoey in Sydney said.

Aided by market tension, gold has shot up to around $2,000 an ounce this week for the first time in a year. Spot gold prices took a breather on Tuesday and fell 1.95% to $1,940 an ounce.

Swiss rules

At the heart of Monday‘s steep drop in banking shares was the $17 billion write-down in Credit Suisse’s “additional tier 1” debt – part of its capital buffers – to zero.

Bondholders usually outrank shareholders in the event of a restructuring or bankruptcy. But Credit Suisse AT1 owners ended up empty-handed, which unleashed a wave of selling in this kind of debt in the European market.

Regulators in Europe and Britain stepped in to reassure investors that it would not set a precedent, and prices stabilised on Tuesday, when it became apparent that the Credit Suisse write-down was more a function of Swiss rules.

With the focus on the outlook for monetary policy, the dollar index edged lower to 103.21 against a basket of currencies around its lowest since Feb. 14, as investors grew confident enough to dip into other assets.

Fed funds futures imply about a 1-in-4 chance of the Fed pausing on Wednesday, according to CMEs FedWatch tool, while markets are divided evenly on the prospect of a hike in Britain when the Bank of England meets on Thursday.

In line with dominant expectations that U.S. rates could rise to between 4.75% and 5% on Wednesday, the two-year Treasury yield rose to 4.1686%, from Mondays close of 3.924%. The yield on 10-year Treasury notes also climbed to 3.5999% compared with its close of 3.477% on Monday.

“The banking sector‘s near-death experience over the last two weeks is likely to make Fed officials more measured in their stance on the pace of hikes,” said Steve Englander, Standard Chartered’s head of G10 FX research.

The dollar rose 0.87% against the Japanese yen to 132.28 and lost out to the euro, which rose 0.41% to $1.0766.