S&P 500 futures erased most earlier gains and traded little changed, while Nasdaq futures trimmed their advance and the Cboe Volatility Index spiked, set for the highest since end-October. Turmoil continued to engulf shares in regional banks as investors who saw equity stakes wiped out at Silicon Valley Bank and Signature Bank rushed out of the industry.

First Republic Bank remained under pressure, with shares plunging 70% in US premarket trading even after the lender moved to try and quell concern about its liquidity after the failure of SVB. PacWest Bancorp lost more than 40%, Western Alliance Bancorp sank 30%, Charles Schwab Corp. dropped about 20% and Zions Bancorp fell 15%. Comerica Inc. slid 7%.

While higher rates are often thought to buttress interest income, the issue is complicated in 2023 by a steeply inverted yield curve that depresses yields on longer-dated assets versus short-term liabilities. Retaining deposits is hard when money market rates are as much as 50% higher than interest paid on savings accounts. And if deposits flee, banks may be forced to book what had only been paper losses on mortgage bond and Treasury holdings they are forced to sell.

The buckling shares highlighted that even after emergency measures by US regulators, including a new backstop for banks, investors remained on edge that more seizures were possible. Broadly, the government actions bolstered markets, though overnight gains wobbled as investors poured into fixed income investments. The latest crisis poses a risk to the strong rally seen in US and European shares since October. 

“The market has been shaken by the recent events and the positive mood cannot return in the short term so I would eventually expect more weakness and more scrutiny from the market to some leverage situations and illiquid assets,” said Alberto Tocchio, a portfolio manager at Kairos Partners. “There wil

European stocks retreated the most since mid-December amid a drop in banking shares after HSBC Holdings Plc agreed to buy the UK arm of Silicon Valley Bank. Biggest fallers included Commerzbank AG, BAWAG Group AG and Banco BPM SpA. Credit Suisse Group AG slumped as much as 15%. Italy’s FTSE MIB Index underperformed other regional benchmarks due to its large exposure to banks. l be a search for the next victim and the recession probability is set to increase over the next weeks.”

“After the liability-driven investment fund crisis in autumn 2022, we see this is another episode where parts of the financial system are hit by the unwinding of accommodative central bank policy,” said Deutsche Bank analyst Benjamin Goy.

While US regulators introduced a new backstop for banks that Federal Reserve officials said was big enough to protect the nation’s deposits, the surprise announcement that New York’s Signature Bank was being shuttered reminded investors that further turmoil, at least among regional banks, was still possible. A senior US Treasury official said some institutions had issues similar to the failed Silicon Valley Bank.

Most large US banks also erased earlier gains in US premarket trading, with JPMorgan Chase & Co., Bank of America Corp. and Wells Fargo & Co. all trading lower. 

“We’re seeing a liquidity withdrawal, the classic thing that you’d expect following a credit event like what’s happening at SVB,” said Haig Bathgate at Atomos Investments. “People get scared, reduce exposure to equities and move into government bonds. They’re wondering if anyone else will be in this position as these things don’t tend to happen in isolation.”

Government intervention managed to avert deposit losses, but deposit migration to large banks may keep the pressure on some lenders, Wells Fargo strategists including Christopher Harvey said in a note. Harvey said he wouldn’t buy risk now and sees Tuesday CPI print as a wild card. 

US stocks tumbled at the end of last week when Silicon Valley Bank suddenly collapsed in the biggest such incident since the global financial crisis. The Fed’s aggressive tightening campaign has sent interest rates surging, leaving some banks holding long-dated bonds that have plunged in value at the same time their financing costs are surging.

“I don’t think the system as a whole is inherently financially unstable, certainly systemic risk has been considered low,” Susannah Streeter, Hargreaves Lansdown, head of money and markets, said in a Bloomberg TV interview. “But what I think you’re seeing is this risk averse nature really sweeping through and renewed worries just about higher interest rates being elevated for longer and the repercussions of that.”

“I actually think that what happened this morning is that investors have woken up to the fact that a very serious situation has been averted and I think the seriousness was just underestimated actually,” she added.

As a result of the latest turmoil, Goldman Sachs Group Inc. economists said they no longer expect the Fed to deliver a rate increase next week.

“The market is likely to remain very cautious despite regulators stepping in,” said Marija Veitmane, senior multi-asset strategist at State Street Global Markets. “This is a difficult position Fed is in, on the one hand it needs to keep hiking to arrest inflation, but also it needs to protect the financial system. Feels like a lose-lose situation for the Fed and the market.”