The title of Catch-22, the 1961 satirical war novel by Joseph Heller, refers to a dilemma that arises from mutually conflicting conditions. The phrase entered the language.

I now turn your attention to the Federal Reserve’s Catch-22. Higher interest rates combat inflation, but higher rates also exacerbate the pressure on the beleaguered banking sector. Can monetary policymakers solve this seemingly unsolvable problem?

In a survey published on May 1 by the World Economic Forum, the latest bank failures are sounding alarm bells within the economics profession. More than 80% of chief economists currently assert that central banks “face a trade-off between managing inflation and maintaining financial sector stability.”

These economic boffins argue that higher interest rates are revealing cracks in the global financial sector, hamstringing the ability of central banks to curb inflation.

I found this pessimistic sentiment startling, because it represents a significant departure from the soothing assurances of the Wall Street elite that the banking sector is generally sound and the failed banks represent just a few bad apples.

U.S. Treasury Secretary Janet Yellen has repeatedly proclaimed that large withdrawals from regional banks have “stabilized.”

At his press conference Wednesday, Fed Chair Jerome Powell said the U.S. banking system is “sound and resilient” and that the conditions in the banking sector have “broadly improved” since early March.

The Fed hiked rates by 0.25% on Wednesday, in its effort to curb rising prices. But each hike in the fed funds rate puts the squeeze on smaller banks. Many lenders are incurring losses on older securities and loans, which pay low interest rates relative to newer securities. This dynamic was a major factor in the collapses of Silicon Valley Bank, Signature Bank, and New Republic Bank.

On Thursday, shares of PacWest Bancorp (NSDQ: PACW) plummeted more than 50%, after reports surfaced that questioned the bank’s stability. The shares of other regional banks thought to be in trouble, notably Western Alliance Bancorporation (NYSE: WAL), were caught in the downdraft.

If you’re a bargain hunter, you might be tempted to view the regional banking slump as a rare opportunity to buy undervalued but intrinsically sound bank stocks on the cheap.

However, if the chief economists surveyed by the World Economic Forum are correct, we could be on the cusp of a domino effect in the banking sector.

There’s a Wall Street saying: Never try to catch a falling knife. A falling investment could rebound. Or it could lose more value. Trying to predict the bottom is like grabbing a knife on its way down. Pain usually ensues. When it comes to the banking sector right now, there could still be plenty of pain to go around.

Glad tidings from the jobs market and Apple…

In the meantime, the overall economy continues to show signs of strength, as evidenced by the government’s latest jobs report and the fiscal second-quarter operating results of Apple (NSDQ: AAPL).

The Labor Department reported Friday that employers added a robust 253,000 jobs in April, an indication that the tight labor market is shoring up the U.S. economy despite elevated inflation and banking industry tumult.

The analysts’ consensus had called for payroll gains of 180,000. The nation’s unemployment rate fell to 3.4% from 3.5% in the prior month.

As the chart shows, we saw a huge improvement in the prime-age labor force participation rate, which rose to 83.3% in April, which is the highest since March 2008:

Source: Bloomberg

After the closing bell Thursday, economic bellwether Apple announced fiscal Q2 earnings that brought renewed optimism to Wall Street.

The Cupertino giant beat analysts’ expectations on the top and bottom lines. Revenue was $94.8 billion versus $92.6 billion expected; adjusted earnings per share came in at $1.52 vs $1.43 expected; and iPhone sales reached $51.3 billion vs $48.9 billion expected. Mac and iPad sales fell short of estimates.

Apple didn’t provide formal guidance, a practice that dates back to the pandemic in 2020. But the company’s better-than-expected quarterly performance sent its shares higher and cheered the markets.

The main U.S. stock market indices closed sharply higher Friday, as follows:

• DJIA: +1.65%
• S&P 500: +1.85%
• NASDAQ: +2.25%
• Russell 2000: +2.39%

All 11 S&P 500 sectors finished Friday’s session in the green, with energy, technology, and financials leading the way. Apple shares jumped 4.69%. The regional banking sector rebounded, with the benchmark SPDR S&P Regional Banking ETF (KRE) rising 6.29%.

West Texas Intermediate (WTI) crude oil spiked more than 4% on Friday to close above $71 per barrel, although for the week WTI was still down 7%.

European and Asian stocks generally closed higher Friday as well. The European Central Bank (ECB) strengthened the confidence of global investors by raising interest rates a quarter point Thursday. That’s the smallest rise imposed by the ECB since it started raising rates last summer, although policymakers made it clear that the fight against inflation isn’t over.

Apple’s Q2 report card was the main driver of optimism Friday. That said, Apple didn’t escape the global decline in PC sales. According to a report from Gartner, worldwide shipments of computers plummeted 30% year-over-year in the first quarter of 2023.

Friday was a good day and the major U.S. stock indices snapped their losing streak, after closing in the red for four consecutive days, but the Dow, S&P 500 and Russell 2000 are still down for the week, with the tech-heavy NASDAQ barely eking out a gain.

The mix of good news/bad news will continue to roil markets, until we get further clarity on both inflation and the banking sector’s woes. The Fed’s Catch-22 remains in force.

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John Persinos is the editorial director of Investing Daily.

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