Bank credit downgrades hits Banks in the S&P 500 and Russell 2000

Wall Street sold off as traders digested S&Ps Bank credit downgrades led unsurprisingly by leading Banks, and the S&P 500 and Russell 2000 in which they feature large, with the Nasdaq unchanged. Bond yields are creeping up to levels last seen in 2007, with 2- and 10-year yields at 5.03% and 4.33%. Bad news for banks and borrowers, notably as mortgage rates have climbed to above 8% for 30-year fixed rates.

Bottom-line: risk-off.

TODAY’S MAJOR NEWS

US bank downgrades

S&P Global listed higher funding costs and problems in commercial real estate as challenges that led it to downgrade credit ratings for multiple regional banks late Monday. The KBW Banks and Regional Bank indexes were down 2.1% and 2.4% by lunchtime. The downgrades increase borrowing costs for the banks, already on the rise. This week’s rise in 10-year Treasuries to 16-year highs further raises risks for the commercial real estate sector – and the banks which finance that sector – as well as other banks who simply do not have protection in place to guard against rising rates.

S&P ratings were downgraded for UMB Financial Corp, Comerica Bank, and KeyCorp on large deposit outflows, higher interest rates, funding risks, and Associated Banc-Corp and Valley National Bancorp their higher reliance on brokered deposits. S&P Global also cut its outlook to “negative” from “stable” for S&T Bank and River City Bank due to higher commercial real estate exposure. Moody’s cut its credit rating for ten regional banks earlier this month, while Fitch stated last week that it could reduce ratings if the sector’s “operating environment” were to deteriorate further.

Bank credit fears and higher interest rates – we’ve been here before

Bond markets have a lot to worry about: lingering inflation, more Fed rate rises, a faltering property market, weaker bank balance sheets. Perhaps it’s not a surprise that some traders are casting back to 2007, when interest rates were last at current levels. In 2007, subprime lenders began to file for bankruptcy, two big hedge funds failed, weighed down by subprime loans, and panic gripped financial markets faced with the scale of the credit crisis, and whether solutions were even possible. The S&P 500 halved in value between its October 2007 peak and February 2009 low, despite the Fed slashing interest rates close to zero. Of course, there are many differences, but there also similarities, notably the central role played by the bank sector and questions about their credit worthiness.

Bank problems might figure in Fed’s interest rate decision

Bank downgrades are a reminder that risks remain for the US economy as the Federal Reserve contemplates its next interest rate move when it meets in four weeks. Traders put 45% odds of another rate hike this year, reflecting a gradual shift in sentiment on Wall Street in that direction. We’ll get another chance to hear from Fed Chair Jerome Powell on Friday when he addresses participants at the annual Jackson Hole, Wyoming symposium. Expect him to echo the mantra that the Fed will remain data driven, but be prepared for rates that are “higher for longer.” We have not yet seen the changes in the data points that the Fed has frequently stated are its focus, and the Fed has clearly communicated on many occasions that it would rather error on the side of too high for too long than to pivot too soon.

TODAY’S MAJOR MARKETS

Equity markets sell off, led by broad indexes

• Equity markets fell in morning trade, with the S&P 500 and Russell 2000 off 0.3% and 0.4% respectively, while the Nasdaq was unchanged
• Global markets were stronger overnight, led by Nikkei 225 up 0.9%, the DAX up 0.7% and the FTSE 100 up 0.2%
• The VIX, Wall Street’s fear index, rose to 17.2

Bond yields rise to new highs, dollar rallies

• Bonds crossed key psychological levels, with 2-year bonds a shade at 5.03% and 10-year 16-year high at 4.33%, levels last seen in 2007
• The dollar index was up 0.3% against a basket of currencies to 103.6, a new short-term high, with the Euro and Sterling cross rates down by 0.4% and 0.2%, and the Yen rising 0.2%

Oil and Silver lead commodity markets

• Crude oil prices were mixed on fears of ebbing China demand, unchanged at $80.8 per barrel
• Gold rallied after a sharp decline, up 0.2% to $1,926 per ounce, while Silver rose 0.5% to $23.4 per ounce

• The grain and oilseed sector is broadly lower as well, led by sharp losses in soybean prices
• The strong dollar was a factor in today's weakness, creating broad-based weakness for the commodity sector, but the Midwest crop tour has also failed to provide notable fodder for the bulls to this point

Analysis by Arlan Suderman, Chief Commodities Economist: Arlan.Suderman@StoneX.com 

Market outlook by Paul Walton, Financial Writer: Paul.Walton@StoneX.com