Regional bank concerns continue to weigh on USD vs. FX majors

USD: Regional bank concerns back in focus ahead of next week’s FOMC meeting

The US dollar has been relatively stable overnight after a more volatile trading session yesterday when it hit a fresh year to date low against the euro. The euro briefly rose sharply against the US dollar to an intra-day high at 1.1095 with the pair trading above the 1.1000-level this week for the longest sustained period late March/early April of last year. While the US dollar has weakened further this week against the other major currencies of the euro, pound, yen and Swiss franc, it has still outperformed against the G10 commodity currencies of the Australian dollar, Canadian dollar and Norwegian krone. The price action remains consistent with more risk off trading conditions recently as market participants have become more concerned over: i) the health of First Republic Bank, ii) the slide in iron ore prices that is casting some doubt on the strength of the recovery in demand from China, and the iii) the looming debt ceiling stand-off that could deliver another negative shock to the US economy on top of tighter credit conditions resulting from the loss of confidence in regional banks. Bloomberg has reported overnight that the FDIC has been giving first Republic Bank time to reach a private deal to shore up its finances. But with time passing by without a deal, they are increasingly weighing up whether to downgrade their Camels rating of the firm’s condition that would likely limit their ability to use the Fed’s discount window and emergency lending facilities according to Bloomberg. The report alongside the ongoing plunge in their stock price will add to building concerns that First Republic Bank is running out of time to avoid a similar fate to Silicon Valley Bank. One silver lining this week has been that concerns over the health of First Republic Bank appear more contained than when Silicon Valley Bank fell into trouble last month. The KBW Bank equity index has back fallen towards last month’s lows but has not fallen as sharply as during the first half of March.

Fresh concerns over the health of First Republic Bank are though having some impact on Fed rate hike expectation ahead of next week’s FOMC meeting on 3^rd May. The US rate market still expects the Fed to deliver one final 25bps hike but is less confident now with 19bps priced in for next week. The US rate market has also moved to price back in a higher probability of the Fed delivering up to 50bps of rate cuts by the end of this year. In light of current market pricing we still expect the Fed to hike again next week but we are even more confident that the policy guidance will be more dovish by delivering a stronger signal that they are going to pause their hiking cycle to assess the impact of the tightening in financial conditions on the economy.  It supports our outlook for the US dollar to weaken further against other major currencies in the near-term. Yield spreads between the euro and US dollar are now back to levels that were in place around a decade ago when EUR/USD was trading significantly higher than current levels. It makes us more wary that our bullish forecasts for EUR/USD are too cautious (click here). We are currently in the process of revising higher our forecasts in our next monthly FX Outlook report to be released at the start of next week.    

EUR/SEK CLOSE TO YEAR TO DATE HIGHS AFTER RIKSBANK UPDATE

Source: Bloomberg, Macrobond & MUFG GMR

SEK: Riksbank’s cautious rate guidance undermines desire for stronger krona

The Swedish krona was one of the biggest movers yesterday following the Riksbank’s latest policy update. The krona weakened sharply and fell back towards the year date lows against the euro, although it did hold up better against the Norwegian krone and US dollar that have been weakening as well. It helped to lift EUR/SEK back up to the 11.400-level which has been a strong resistance level for the pair so far this year when it has been tested and held in February, March and earlier this month. The krona weakened yesterday even though the Riksbank delivered another larger 50bps rate hike that lifted their key policy rate to 3.50%, and reiterated that they want a stronger krona to help combat upside inflation risks.

However, the Riksbank fell short of meeting market expectations that were looking for even more hawkish policy guidance. While the Riksbank acknowledged that core inflation has been much higher in the first months of this year, the upward revisions to the Riksbank’s key policy rate forecast profile were relatively cautious. The Riksbank is now signalling that it plans to deliver one more 25bps hike in either June or September which sends a signal that it feels it is close to the end of their hiking cycle and upside inflation risks are almost back under control. The two deputy governors also voted against yesterday’s 50bps hike. 

The negative krona reaction highlights that market participants do not share the Riksbank’s optimistic outlook on inflation. The Riksbank did acknowledge though that they may need to hike more if the krona does not strengthen as they would like. In contrast to the Riksbank’s updated guidance, we expect next week’s updated guidance from the ECB to stick to a more hawkish tone. We expect the ECB to acknowledge that it has more work to do to meet their inflation goal. It will keep upward pressure on EUR/SEK and lift the pair to fresh year to date highs above the 11.482-level from 13^th March.   

KEY RELEASES AND EVENTS

Country	GMT	Indicator/Event	Period	Consensus	Previous	Mkt Moving
EC	10:00	Consumer Confidence	Apr	-17.5	-17.5	!!
US	13:30	GDP (QoQ)	Q1	2.0%	2.6%	!!!
US	13:30	Initial Jobless Claims	--	248K	245K	!!!
US	15:00	Pending Home Sales (MoM)	Mar	0.5%	0.8%	!!

Source: Bloomberg