In a sign of how fragile the banking system still is, U.S. regional banks rebounded sharply at the mere prospect of a government guarantee, then pared some of those gains after regular hours.
Note that Yellen didn't say the government would unequivocally help all small banks. These are her exact words, with emphasis added by me: "Similar actions could be warranted if smaller institutions suffer deposit runs that pose the risk of contagion." In other words, her statement had two important qualifications banks need to meet before the government would even consider stepping in: first, the bank must suffer a run; second, it must be important enough that its collapse would affect the rest of the banking sector.
Essentially, that's not so different from what Yellen said last Thursday — that the government would swoop in if "failure to protect uninsured depositors would create systemic risk and significant economic and financial consequences." But investor confidence is currently so low that any reassuring comment, vague as it might sound, will sound like a promise.
Not that reassuring comments are necessarily bad. Indeed, Yellen's remarks on Tuesday were good for markets. The Dow Jones Industrial Average rose 0.98%. The S&P 500 added 1.30% and hit 4,002.87, its first time since March 6 that it's ended the day above 4,000 since March 6. The Nasdaq Composite jumped 1.58%.
Tomorrow, we'll hear from the Federal Reserve and find out whether it's hiking interest rates even amid the turmoil in banks. Markets are pricing in an 86% chance of a quarter-point increase — though that number is mostly conjecture, since the Fed has been unusually — though understandably — quiet about its intentions.
Paradoxically, analysts think the Fed should hike rates not just because inflation remains uncomfortably high, but also because it would signal confidence the Fed can "walk and chew gum at the same time," said Michael Gapen, chief U.S. economist at Bank of America. Indeed, a pause might have the opposite effect of spreading fear — "that would be the same as acknowledging that [Fed officials] know something that maybe the markets don't know," which would be "devastating" for markets, said Johan Grahn, head of ETF strategy at Allianz Investment Management.
And even though markets looked surprisingly resilient even amid two weeks of bank trauma, it's not clear how much more devastation markets can absorb — nor does anyone wish to find out.
