Why are markets reacting on Tuesday with stock sell-offs due to bank downgrades, causing treasuries and the dollar to rally as safe-haven demand increases?

On Tuesday, the market experienced a risk-off session with concerns centered around U.S. banks, which received downgrades from Moody’s. The credit ratings of 10 smaller banks were lowered, and Moody’s warned of potential downgrades for six major U.S. banks. This led to a 10% jump in the VIX, reaching its highest level since late May. All major indices and sectors, except for healthcare, traded in the red. The negative macro themes overshadowed the ongoing positive earnings season for corporations. The sell-off also affected Europe after the Italian government announced a surprise tax on banks’ windfall profits. This caused investors to flock to safe-haven assets, resulting in a rally in Treasuries and a rise in the dollar. The S&P 500 fell nearly 1%, reaching its lowest level since June 12, while the Dow slipped by 270 points or 0.8%. Both the Nasdaq 100 and the Russell 2000 tumbled 1.4%. Analysts noted that stocks have surpassed their fundamental value but acknowledged the impressive resilience of the economy. They recommended a neutral tactical allocation to equities with a modest overweight to fixed income. In terms of ETFs, the SPDR S&P 500 ETF Trust, SPDR Dow Jones Industrial Average ETF, and Invesco QQQ Trust all experienced fluctuations in their values. The majority of U.S. equity sectors were negative, except for the Health Care Select Sector SPDR Fund, which saw a slight increase. Philadelphia Fed President Patrick Harker made dovish remarks, suggesting a patient approach by the Federal Reserve in maintaining interest rates. In terms of individual stocks, Eli Lilly & Co. saw a significant increase, while Lucid Group Inc., International Flavors and Fragrances Inc., and Datadog Inc. experienced declines. In commodity and bond markets, crude oil fell, treasury yields decreased, and the dollar rallied. European equity indexes closed in the red. Gold and silver prices also fell, while Bitcoin experienced a slight increase.