Traders see growing chance of Fed rate hike in May, pause or cuts thereafter

Investors have been struggling with two competing theories, which Joe Kalish of Ned Davis Research described as the “cockroach theory” versus the idea that lightning-never-strikes-the-same-place twice.

The first theory refers to the notion that there is “never just one” cockroach, he wrote in a note, suggesting that the banking-sector’s woes may not be contained to only a small circle of banks.

The second theory focuses on the idea that the unfolding turmoil at some banks looks meaningfully different than the 2008 financial crisis, which had more to do with how to value opaque assets. The current pressures, he said, boil down to a liquidity problem, including if more depositors pull their money from banks.

Wall Street is divided over what happens next. While economist David Mericle of Goldman Sachs
GS,
+2.37%
expects the Fed to pause on Wednesday, BofA Securities’ Mark Cabana, Michael Gapen, and Alex Cohen are forecasting a “jittery” 25-basis-point hike. The BofA team also see the Fed ending its rate-hike campaign between 5.25% and 5.5% versus the current level of 4.5% to 4.75%.

Overnight indexed swaps (see chart) show how sharply the Fed’s most likely path forward has been repriced following the emergence of risks in the banking system. Those swaps reflect only a slight, near-term bump up in the fed-funds rate target before rate cuts are then factored in for the remainder of 2023.

As of Monday morning, Treasury yields were broadly higher after investors shook off a bout of risk aversion seen earlier in the day. U.S. stock indexes
DJIA,
+1.17%

SPX,
+0.78%

COMP,
+0.10%
were mixed heading into afternoon trading.