Wall Street’s fear gauge crumbles with risk-on bid

Wall Street’s favorite volatility gauge tumbled as a rebound in stocks deepened, with a surge in banks and assurances from global authorities easing concerns that the recent financial tumult would lead to a full-blown crisis.

Call it calm. Or call it calm before the storm.

Whatever the case, the coordinated actions to resolve the banking turmoil have restored a semblance of order for now. The market’s so-called fear gauge, or VIX, headed toward its biggest two-day plunge since May. In the run-up to the Federal Reserve decision, traders are betting on another 25 basis-point hike, with officials forging ahead with the battle against inflation and signaling commitment to financial stability.

“This is an easier market backdrop,” said Nicholas Colas, co-founder of DataTrek Research. “Expectations of a dramatic about-face for monetary policy are diminishing. Market expectations for near-term Fed rate decisions are now within the realm of the possible. That is good news.”

The S&P 500 topped 4,000, extending its advance above the key 200-day moving average. After briefly exceeding 30 last week for the first time since October, the Cboe Volatility Index plummeted to around 22. Every stock in a measure of U.S. financial heavyweights climbed.

Now the rally in the riskier corners of the market doesn’t mean an all-clear at this stage.

To Matt Maley at Miller Tabak, investors should be careful about the conclusions they draw from the recent equity advance as there are at least two ways to look at it.

“One is to think that the stock market is looking past this mini-crisis and sees that the economy (and thus earnings) are going to grow quite nicely once we get past this problem,” Maley said. “The other way to look at it is to think that the situation is still quite a dicey one, and the authorities are pumping so much short-term liquidity into the system that the stock market cannot decline over the near term.”

Several strategists are indeed growing concerned, with Morgan Stanley’s Michael Wilson saying the risk of a credit crunch is increasing materially. The S&P 500 might find a floor at 3,800, but investors should sell into any rallies if the benchmark reaches 4,100 to 4,200, Bank of America’s Michael Hartnett wrote.

BofA’s latest global survey of fund managers showed a systemic credit event has replaced stubborn inflation as the key risk to markets. The polling took place from March 10-16, while money managers were witnessing the collapse of U.S. lenders Silicon Valley Bank and Signature Bank and monitoring the turmoil at Credit Suisse before its historic takeover by UBS. The likelihood of a recession is rising again for the first time since November, with the survey showing a net 42% of participants expecting a slowdown over the next 12 months.

Another worrisome development is the extreme volatility in short-term government bonds that has now dragged into a ninth straight day. Treasury two-year notes, which are normally considered a low-risk investment, saw its yield surge as much as 21 basis points to 4.18% Tuesday.

John Hancock Investment Management’s Matthew Miskin is certain the Fed has run out of runway for a soft landing, and he’s pointing to turbulence in the bond market to make that case.

“When the two-year Treasury yield starts acting like a meme stock, you’ve got some problems,” Miskin said Tuesday on Bloomberg Television. “The bond market is saying, ‘yeah, you’re going to raise rates but it’s going to be a mistake and you’re going to be cutting in the not so distant future.’”