Will banking fears deliver another negative shock to global growth?

USD: Fears over banks continue to drive FX market  

The major foreign exchange rates have made a quiet start to the week with the dollar index continuing to trade nearer to the bottom of the year to date range between 102.00 and 106.00 although it has recovered initial losses following last week’s FOMC meeting. The US dollar rebound on Friday was primarily driven by renewed concerns over the health of European banks in particular Deutsche Bank that saw its share price fall sharply by around 15% from the closing price on Thursday.  The price of the bank’s five-year credit default swaps also jumped from below 150bps on Wednesday to 200bps on Friday according to data from Refinitiv. The price action further highlights that the actions taken by policymakers including the merger between Credit Suisse and UBS have not yet been sufficient to restore confidence in the banking system.  When asked if Deutsche Bank was the “new Credit Suisse”, Germany’s Chancellor Olaf Scholz stated on Friday that “Deutsche Bank has fundamentally modernised and reorganise its business and is a very profitable bank…there is no reason to be concerned about it”.

ECB President Lagarde who was attending a euro-zone summit in Brussels also attempted to provide reassurance that the banking sector was “strong” and that the ECB was fully equipped to provide liquidity to the euro area financial system if needed according to an EU official. For now, she reiterated that there was “no trade-off” between controlling inflation and fostering financial stability.   

Over in the US, Fed officials are becoming more concerned over the negative impact on the US economy from the loss of confidence in US regional banks. When asked in an interview yesterday whether recent banking strains could tip the US economy into recession, Minneapolis Fed President Neel Kashkari stated that “it definitely brings us closer”. He added that “what’s unclear for us is how much these banking stresses are leading to a widespread credit crunch. Would that slow down the economy? this is something that we’re monitoring very, very closely”. He is a voter on the FOMC this year. The comments support market expectations that the Fed is close to ending their rate hike cycle and may even be forced to cut rates later this year if the US economy falls into recession. There are currently only around 7bps of further Fed hikes priced into the US curve and around 80bps of cuts by the end of this year.  While the sharp move lower in US yields in recent weeks has weighed on the US dollar, we would expect further weakness to be against a narrower range of currencies if fears over a sharper global slowdown intensified. In the current circumstances, we continue favour US dollar downside against the yen after USD/JPY briefly broke back below the 130.00-level on Friday.      

BANK SHARE PRICES CONTINUE TO CORRECT LOWER

Source: Bloomberg, Macrobond & MUFG GMR

Commodity FX: Banking disruption heightens risk of hard landing

The worst performing G10 currencies over the past week have been the high beta G10 commodity currencies of the AUD (-1.0% vs. USD), NZD (-0.7% and CAD (-0.5%). It has meant the G10 commodity currencies have only managed more modest gains against the USD since global banking fears intensified in recent weeks. The AUD and CAD have strengthened by less than 1% against the USD since 8th March compared to much bigger gains for the JPY (+5.0%), GBP (+3.3%) and SEK (3.0%). The G10 commodity currencies have failed to derive as much support from the dovish repricing of Fed rate hike expectations. There has been a significant shift in Fed rate expectations over the past week with the US rate market now more confident that the Fed has finished hiking rates, and has moved quickly to price in around 100bps of cuts by the end of this year.  

The move lower in US yields has also resulted in a sharp steepening of the US yield curve as short-term yields have adjusted lower by a larger amount than long-term yields. The yield spread between 2 and 10-year UST yields has become much less negative as it has risen from a low of around -1.08% on 8th March to -0.46% today. It has been the sharpest steepening of the US yield curve over an equivalent 12-day trading period since 1982. The price action in the fixed income market adds to investor concerns that the US economy is moving closer to falling into recession. There is a strong historical pattern of the US yield curve steeping sharply just before or at the start of US recessions when the curve had become inverted.

A similar bearish signal has been delivered at the start of this year by the commodity market. Bloomberg’s commodity index is on course to decline for the fourth consecutive month and has extended the sell-off since last year’s peak in June to around -26%. Market participants are clearly fearful that the loss of confidence in the health of the banking sector will provide another significant negative shock to the global economy through tighter credit conditions which comes on top of the lagged impact from the aggressive monetary tightening delivered by major central banks over the last year or so. Those downside risks are currently outweighing investor optimism over the potential for a pick-up in demand for commodities from China as its economy reopens. Our commodity analyst still expects commodity prices to rebound this year. But in the current circumstances, we believe that risks remain titled to the downside for G10 commodity currencies in the near-term. We do not expect banking fears to blow over quickly and they pose downside risks to global growth through tightening credit conditions. Nevertheless, it is premature to rule out a boost for commodity currencies later this year from a stronger than expected pick-up in demand from China. Please see our latest FX Weekly or more details (click here).

G10 COMMODITY CURRENCIES CONTINUE TO UNDERPERFORM

Source: Bloomberg, Macrobond & MUFG GMR

KEY RELEASES AND EVENTS

Country	GMT	Indicator/Event	Period	Consensus	Previous	Mkt Moving
EC	08:30	ECB's De Cos Speaks				!!
SZ	09:00	Total Sight Deposits CHF		--	515.1b	!!
GE	09:00	IFO Business Climate	Mar	91.0	91.1	!!
EC	09:00	M3 Money Supply YoY	Feb	3.2%	3.5%	!!
EC	09:30	Bundesbank Chief Nagel Speaks in Karlsruhe				!!!
UK	11:00	CBI Retailing Reported Sales	Mar	-3.0	2.0	!!
EC	14:40	ECB's Elderson Speaks in Amsterdam				!!
PO	15:00	ECB's Centeno Speaks at OMFIF Event				!!
US	15:30	Dallas Fed Manf. Activity	Mar	-10.0		!!
EC	16:00	ECB's Schnabel Speaks				!!!
US	22:00	Fed's Jefferson speaks				!!!

Source: Bloomberg