Markets, investors in a ‘wait-and-see mode’ amid financial system distress: Strategist

Opimas CEO Octavio Marenzi and RBC Capital Markets Head of U.S. Equity Strategy Lori Calvasina join Yahoo Finance Live to discuss how the financial instability tied to Silicon Valley Bank and First Republic Bank is weighing on markets ahead of the Fed's next interest rate hike decision.

Video transcript

INES FERRE: The ongoing bank drama has been ramping up volatility across the major indices, the Dow and S&P and the NASDAQ all in the green this afternoon after opening the session lower. Joining us for more on the markets is Optima CEO Octavio Marenzi and RBC Capital Markets head of US equity strategy Lori Calvasina. Octavio, let's start out with you. What is your reaction regarding what we're hearing of this possible rescue plan from these bigger banks for First Republic and what the market reaction that we're seeing with these regional banks right now?

OCTAVIO MARENZI: Well, the market reaction seems to be very positive. So I guess it's sort of buying the story and saying this looks really encouraging. It looks like First Republic is not going to go under. The large banks are stepping in, and they're going to put in the deposits to make sure that happens. However, we haven't really seen the details of this plan.

A big question I would have is how much are these large banks going to charge First Republic for these deposits. Are they just going to put it into a checking account and get 0% interest in it? That means they're going to take a big loss because they could be getting 4% or 5% on that by just putting it into short-term US treasuries.

So those deposits might come at quite a high cost for First Republic, though they haven't said exactly how that's going to work. I suspect the large banks are in it to make money. They're not going to give something away to First Republic. So they're going to ask for a very, very substantial amount of money on interest to be paid on that money. And that will wreck First Republic's income statement.

SEANA SMITH: Laurie, how are you looking at this, just in terms of the risk that this potentially poses to the broader market? Yes, the market's reacting in an optimistic way right now to the latest developments of this. But still, you still have that lingering risk out there about some of the instability within the banking sector.

LORI CALVASINA: So it's interesting. I actually have sort of a different take than most people on the price action this week. And if you look at today-- and whenever big events happen, I always watch the sectors. I think that's the best way to interpret how the market's feeling. And what we're seeing today is actually somewhat similar to what we've seen all week. So, yes, the financials are doing well. But it's actually-- I'm looking at my screen-- communication services, tech, consumer discretionary, the big kind of growth engines of the S&P 500 are what are really still leading the pack.

And as we look back over the past week, we've really seen more evidence of rotation from things like the financials into these growthy areas, areas that tend to do, frankly, well when interest rate expectations and Fed fears are coming down. So today, we are seeing a good reaction in the market, but we're also seeing a continuation of some of these growthy areas doing very, very well. And it's really that that's been bolstering the market and keeping it resilient all week.

INES FERRE: So are you seeing, when you're talking about the sectors, I mean, I'm pulling up right now a four-day chart, and we're seeing on our YFi Interactive that financials down 3% over the last four days. We have seen a lot of volatility when it comes to this sector, of course. So do you think that there is more trouble ahead despite these measures, these lifelines?

LORI CALVASINA: You know, I think it's not for me to say. I think that we're in a wait and see mode. I think that we need to really look to the experts on the banks to really get a sense of that, and they need time to digest some of this information. But I do think that what we have seen when you look at some of the initial corporate reactions-- and we did a piece on this the other day-- was that there was a lot of discussion about how the initial damage and the initial fallout from the situation was fairly sort of limited in terms of companies saying, did we have cash? Did we have a business relationship, yes or no?

So I think it's really going to be a question of derivative impacts down the road that really kind of matters for my world and market pricing, but I think that we have seen very kind of healthy resilience underneath the surface. So I think you've seen very extreme moves in the bond market this week. But the S&P 500 has actually been behaving very, very well. And I think that's something to be taken note of here.

SEANA SMITH: Yeah, up just about 1 and 1/2% today. Octavio, a lot of questions here about what the bank failures over the last week, what that could potentially mean for the Fed at its meeting next week. What do you think the Fed is likely to do? If we were to see a 25 basis point hike, what message would that send and how do you think the markets would react?

OCTAVIO MARENZI: Well, I think the Fed is really stuck in a very difficult situation right now because on the one hand, they're trying to fight inflation. And the only tool at their disposal really to do that is to jack up interest rates and try and reduce the money supply and drive down inflation that way.

On the other hand, they've got the banks screaming at them you need to lower interest rates again to basically shore up our balance sheets. Now, ordinarily, if you saw this kind of banking crisis unfold, the Fed and other central banks will just slash interest rates and shore up the banking sector, and everything would be fine. This time around is different. They can't do that. Their hands are tied because they're bitterly fighting inflation. And that seems like it's taking precedence.

We saw the European Central Bank come out today and increase interest rates by 50 basis points. And that, I think, gives the Fed a bit of impetus. I'm not saying the Fed is going to take a cue from the ECB. It usually works the other way around. But in this case, it might give Jay Powell sort of the confidence to also increase interest rates. And the markets took it very well indeed-- surprising. Usually, markets react very badly to those kinds of big interest rates increases. But this time around, they didn't.

So I think Jay Powell and the FOMC is going to take umbrage from that and basically say, OK, that's going to be OK. We can jack up interest rates a bit, at least 25 basis points. And we should be OK. The ECB showed us the way. It didn't really hurt markets. In fact, it did quite the opposite. It helped them. It buoyed them up.

SEANA SMITH: Yeah, that's a great point and very interesting here, especially then also when you take into account what's happening over there with European banks, comparing that here, though, within the US, and then some would argue that the banking issue here within the US, though, is worse. Lori, if we do, in fact, see a 25 basis point hike next week, is that a mistake here?

LORI CALVASINA: So, look, I think there's a question of what the Fed will do versus what they should do. If you talk to our economist Tom Porcelli, he would have told you that the Fed should have stopped hiking rates a long time ago. Yet, they have been on this path. So I think history will be the judge of that. I do agree with Tom. I think they should have stopped already. I think it takes time for the effects to-- of tightening we've already seen that filter into inflation, that filter into the economy. And I do think inflation is headed lower.

But putting all that aside, I think expectations for what the Fed will do have been all over the place the last week or so. We've really seen a lot of gyrations. There's still some time before we head into that meeting for market expectations to shift again. But the market has gotten more comfortable again with the idea of a 25 basis point hike. So if we were to get it, I don't think it would necessarily cause a lot of damage in the short-term. I do think the messaging, though, the press conference always ends up mattering more than the decision in here. And so the language that Powell uses, hopefully, he will not say anything to spook investors, but we'll have to see what ends up happening.

SEANA SMITH: That has certainly been the driver of the markets after the last couple of meetings. Lori, Octavio, great to have you both. Thanks so much.