Equities dropped in the U.S., Asia and Europe on Tuesday as a combination of recession, banking, and debt-ceiling risks facing the world’s largest economy came together and dented the appetite for risk-taking. The decidedly risk-off sentiment began in Asian markets outside of Japan after California’s First Republic Bank reported a disappointing 41% first-quarter drop in deposits in an announcement released late Monday, reigniting worries about the U.S. banking system. European stocks also broadly fell, followed by all three major U.S. stock indexes . It wasn’t just banking issues that weighed on investors, though. Instead, there are a myriad of risks facing the world’s largest economy, including the prospect of an economic downturn, at least one more Federal Reserve interest rate hike next week, and a possible earlier-than-expected date after which the U.S. government may not be able to pay all of its bills.
Within the S&P 500 index, the materials, information technology, energy, and industrials sectors got pummeled harder than financials did. Meanwhile, the Dow Jones Transportation Average fell more than 500 points, or 3.6%, after package delivery giant United Parcel Service Inc. UPS, -9.98% said first-quarter volume was lower than it had expected.
“There’s a fear of a broader slowdown that’s a little bit more fundamental, making people a little more nervous about the prospects for the economy,” said Derek Tang, an economist at Monetary Policy Analytics in Washington. “Any single risk would be enough to worry about, but you’ve got many overlapping — which is unusual — and people need time to figure out how they might each unfold.””Even though banking stress doesn’t seem to be getting worse, it’s still there,” Tang said via phone on Tuesday. “And First Republic is a pretty strong reminder that things can go wrong very quickly and there may be some systemic risk we need to worry about.” In addition, weak tax receipts in April are bringing forward the possibility that the U.S. might reach the so-called X-date in June, after which Treasury may not be able to pay all the U.S. government’s bills unless Congress raises the $31.4 trillion debt ceiling. June would be earlier than expected — which could lead to an “extreme” outcome because “you could have a government shutdown or financial turmoil if the government selectively defaults on its debt, which is unprecedented,” Tang said.The U.S. is usually seen as one of the world’s economic bright spots, and has managed to avoid falling into a recession despite a full year of rate hikes by the Federal Reserve. Tuesday’s data showed home prices and new home sales both rising, for instance — pointing to the economy’s continued buoyancy even as fed-funds futures traders priced in a 70% likelihood of another quarter-point Fed rate hike next week.Under the surface, though, are lingering signs of worry. The most recent data available from the Fed and the Investment Company Institute in Washington revealed that investors were pulling money out of both banks and government-only money-market mutual funds earlier this month. Ben Emons, senior portfolio manager and head of fixed income in NewEdge Wealth LLC in New York, described bank deposits and government-only money-market funds as “a hot potato that no one seems to be willing to hold.”In the Treasury market on Tuesday, investors avoided the 1-month T-bill because of the potential fallout from a debt-ceiling fight. They sold off 1-month bills aggressively, sending the corresponding yield soaring almost half of a percentage point to 4.03% as of 3 p.m. New York time, according to Tradeweb. Read: Debt-ceiling worries flare: Traders see June as month when government may run out of money Meanwhile, fed funds futures traders boosted their expectations for interest rate cuts from the Fed by December, with a 73% likelihood seen that policy makers will drop their main interest-rate target range to between 4.25% and 4.5%, or even lower — after another quarter-point rate hike on May 3.On Tuesday, Dow industrials finished down by 344.57 points, or 1%, the S&P 500 closed at an almost one-month low after falling 1.6%, and the Nasdaq Composite tumbled close to 2%. The U.S. market moves came after major Asian stock indexes closed lower, led by a 1.7% and 1.4% decline, respectively, in Hong Kong’s Hang Seng Index and Korea’s KOSPI Composite Index. All major European indexes also ended lower. Dan Eye, chief investment officer of Fort Pitt Capital Group, which manages $4.3 billion in assets from Pittsburgh, said he saw no single major catalyst that triggered the worldwide drop in stocks, though First Republic Bank’s first-quarter announcement “goes into the concerning category.”The loss of deposits from the banking system “underscores the danger that might be posed to the economy” as banks pull back on lending, making a recession more likely, Eye said via phone. Meanwhile, “we are probably close enough to the X-date that we should start worrying about the debt ceiling as well.”