Markets are eerily calm after the banking chaos

• The S&P 500’s “fear gauge” fell to its lowest level in 15 months after the recent banking turmoil.

• Investors are eerily calm – but heightened uncertainty could rock markets soon, UBS says.

• “The outlook for US equities is challenged,” the Swiss bank said in a recent research note.

Stock markets have been eerily calm since last month’s banking chaos – but tightening credit and tumbling earnings threaten to put volatility back on the menu, according to UBS.

“The outlook for US equities is challenged amid tighter financial conditions, declining corporate earnings, and relatively high valuations,” a team led by the Swiss bank’s CIO, Mark Haefele, said in a research note this week.

The VIX index – which measures volatility by tracking S&P 500 options contracts and is widely seen as Wall Street’s “fear gauge” – fell to its lowest level since January 2022 on Monday, as markets enjoyed a period of relative tranquility despite Silicon Valley Bank’s collapse sparking fears of wider turmoil.

That’s because investors are increasingly confident the Federal Reserve will respond to the chaos by ending its interest-rate hiking campaign soon. Rising rates erode the appeal of stocks because they boost returns from other assets such as bonds and cash, and raise companies’ debt payments. They also increase the cost of mortgages, car loans, credit cards, and other forms of borrowing, curbing demand from consumers and businesses and weighing on corporate sales and profits.

Over 70% of traders expect the central bank to stop raising interest rates at or before its June meeting, according to CME Group’s Fedwatch tool – with the Fed’s benchmark interest rate expected to peak at around 5.25%.

But the relative consensus could soon be shattered by a credit crunch, UBS said.

In the aftermath of SVB’s collapse, analysts are worried that other lenders will be wary of further bank runs and deposit outflows, and therefore offer out fewer loans. They have warned tighter credit could fuel a decline in spending and investment levels that would weigh on stock-market valuations.

Story continues

“While market expectations for the terminal fed funds rate have dropped by 70 basis points since SVB’s collapse, it is hard to believe that a banking crisis and tighter credit conditions have narrowed the range of possible outcomes, especially to the downside,” Haefele wrote.

“We expect credit conditions will continue to tighten with a negative impact on growth,” he added.

Read more: Stocks are entering a danger zone as they’re already pricing in a Fed pause, top Morgan Stanley strategist says

Read the original article on Business Insider