The stock market sentiment in the United States and Europe is quite fragile. Traders fear that the collapse of Credit Suisse, Silicon Valley Bank, and the liquidity issues in other US smaller banks is only the beginning of the upcoming meltdown. But, some speculators feel that the US and European stock market are poised to enter a bullish phase, and they have one reason to believe this, which previously propelled equities to an all-time high.
In terms of monetary policy, central banks often walk in lockstep, and when one large central bank, such as the Fed, takes a dovish approach, another central bank of significant importance is likely to follow suit. Tomorrow, Fed Chairman Jerome Powell will be in the limelight when the central bank announces its monetary policy in the middle of the banking collapse. Traders think that the Fed is likely to modify its monetary policy navigation plan, and that we may hear from the Chairman that contradicts his prior words. The Fed is likely to suspend aggressive interest rate rises in order to stabilise the banking crisis, as price stability may take a back seat for the time being—the precise rationale that prompted the Fed to boost interest rates at a record pace.
Traders also thought the same from the ECB’s President, Christine Lagarde, when she delivered the bank’s interest rate decision a few weeks back. She startled the markets despite the upheaval in the European financial sector—the ECB raised interest rates by 50 basis points as per their initial plan. In her remarks, the President made it plain that she is unwilling to play the trade-off card between inflation stabilisation and financial stability. Lagarde was sure that the bank has the capacity to address these concerns and deliver a solution to the market.
However, investors and traders are not confident in their skills. The heart of the present financial crisis is a significantly greater concern for them. Both the Fed and the ECB, and they have no other relevant instrument to deploy except from slowing their aggressive interest rate raise process.
Hence, going into the Fed event, investors have essentially priced in a 25 basis point interest rate rise from the Fed this week, which is much lower than when Jerome Powell spoke before Congress a few weeks ago. After his speech, it was fairly widely assumed that the Fed would raise interest rates by 50 basis points. But a surprise hawkish move could ruin everything again and could send stocks lower.
The wager that speculators have on the US and European stock markets becoming positive is based on the expectation that a loose monetary policy would return to town—both in the US and in Europe. They are pricing in a rate pause after the Fed’s 25 basis point interest rate boost this month. The ECB will likely use a similar tactic to mitigate the impact of rising interest rates. It is imperative that these speculators should pay close attention to the degree to which legislators may expand their support for depositors. Janet Yellen, the US Treasury Secretary, said today that if the crisis continues, the US would act again to safeguard depositors.
But, I believe that irrespective of how much the US Treasury intervenes or central banks in the EU increase their assistance to put a lid on the financial turbulence, if the Fed and the ECB do not halt and make the essential trade-off, any positive surge is doomed to fade. The odds are stacking up for the Fed to ease up the process of their interest rate hike and this could begin as early this week.
