JPY strengthens further as Credit Suisse deal fails to stabilize markets

Lee Hardman

Senior Currency Analyst

 

Global Markets Division for EMEA

T: +44 (0)20 7577 1968

E: lee.hardman@uk.mufg.jp

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A member of MUFG, a global financial group}

JPY: Credit Suisse deal fails to initially stabilize financial market conditions

The yen has continued to strengthen during the Asian trading session amidst a continuation of more risk averse trading conditions. It has resulted in USD/JPY falling back below the 131.00-level as it moves further below the high from 8^th March at 137.91. It follows the announcement over the weekend that UBS has agreed to buy Credit Suisse for USD3.25 billion to help safeguard Switzerland’s banking system and to attempt to prevent a further loss of confidence in the global banking system. However, the initial market reaction has not been as favourable as hoped as it has failed to stabilize financial markets. UBS is purchasing Credit Suisse for a significant discount. UBS will pay about CHF0.76 a share in its own stock which is well below the Credit Suisse’s closing price of CHF1.86 on Friday. As part of the deal, the government has agreed to provide a loss guarantee of up to CHF9 billion, but only after UBS has borne the first CHF5 billion of losses on specified assets. Credit Suisse and UBS can also obtain a liquidity assistance loan with privileged creditor status in bankruptcy for a total amount of up to CHF 100 billion. Furthermore, the SNB can gran Credit Suisse a liquidity assistance loan of up to CHF 100 billion backed by a federal default guarantee. The structure of the loan is based on the Public Liquidity Backstop (PLB). The SNB is confident that the substantial provision of liquidity will ensure both banks have access to the necessary liquidity, and it supports their mandate to contribute to the stability of the financial system.  While the deal has been endorsed by the Fed, ECB and BoE as “instrumental for restoring orderly market conditions and ensuring financial stability”, one important part of deal is clearly troubling market participants. The Fed has also announced over the weekend that it will enhance the provision of US dollar liquidity with the BoC, BoE, BoJ, ECB and SNB. It will increase the frequency of 7-day maturity operations from weekly to daily from today until at least through to the end of April. The Fed views the US dollar swap lines as an important liquidity backstop to ease strains in global funding markets.  

The troubling part of the deal is the decision to completely write down CHF15.8 billion in Credit Suisse additional tier one (AT1) debt that risks spreading contagion through the European/global  banking system via the repricing of bail-in debt and equity at other banks. It meant that Credit Suisse’s AT1 debt holders lost more than its shareholders and has cast doubt on the hierarchy of claims in the event of a bank failure. AT1s were viewed as senior to stocks. AT1s were introduced as part of the post-global financial crisis regulatory reforms that pushed banks to increase capital levels. They are a form of contingent convertible security, or coco that can be converted into equity if the bank runs into trouble. If a bank’s capital ratio falls below a predefined threshold, AT1 investors can lose their principal or have their investment converted into equity. They are the riskiest form of bank debt in Europe. The announcement has already triggered a sharp sell-off in Asian bank debt and shares overnight. It is now feared that the market for new AT1 bonds will freeze and the cost of risky bank funding will jump. The end result is that investors are now more concerned about credit risk alongside ongoing funding concerns at banks, although the purchase of Credit Suisse by UBS has taken an important financial stability risk off the table. In current circumstances, we continue to recommend a short USD/JPY trade (click here) which is benefitting from the pick-up in risk aversion and less favourable financial market conditions.             

Increasing bank funding costs to dampen growth outlook

Source: Bloomberg, Macrobond & MUFG GMR

USD: Sharp tightening in US financial conditions argues for Fed caution

The US dollar has underperformed since the collapse of SVB triggered a further loss of confidence in the health of US regional banks. The dollar index has declined by around 2% from the intra-day high on 8^th March.  The price action highlights that the recent pick-up in risk aversion has not yet been sufficient to offset the negative impact on the USD from the sharp adjustment lower in US yields and the initial US-focused nature of banking sector fears. 

The US authorities have taken steps over the past week to stem the loss of confidence in US regional banks. The government has guaranteed that all depositors in Silicon Valley Bank will be made whole. The Fed has introduced a new Bank Term Funding facility to provide liquidity support and reduce the risk of other banks having to liquidate their asset holdings and realize losses on their hold to maturity portfolios from the sharp move higher in rates. Furthermore, a consortium of 11 big US banks including JP Morgan and Bank of America have announced that they will inject USD30 billion of deposits in First Republic Bank as they seek to recycle liquidity across the US banking system. Deposits have shifted out of regional banks into big banks and money market funds. According to ICI, US money market funds received more than USD120 billion of net inflows which was the biggest weekly amount since June 2020. While the timely steps taken so far help to diminish the risk of a worsening run on bank deposits, it remains to be seen whether they will prove sufficient to restore confidence on their own. In order to limit disruption in the US banking system, the Fed has already provided  significant support as evident in the latest balance sheet data. The size of assets on   the Fed’s balance sheet jumped by around USD300 billion in the week to 15th March driven by: ai) a record USD153 billion increase in borrowing from the Fed’s discount window and ii) USD12 billion of borrowing from the Fed’s new Bank Term Funding facility. The usage of their liquidity facilities has meant the Fed’s balance has expanded back to levels from November of last year.  It is providing an offset to the shrinking impact on the Fed’s balance sheet from ongoing quantitative tightening (QT) as the Fed continues to allow USD95 billion/month of maturing QE securities held on their balance sheet to roll-off. The re-widening of the Fed’s balance sheet and increase of USD liquidity are negative factors that are encouraging USD selling in the near-term.

The sharp tightening in US financial conditions over the past week will be an important factor for Fed policymakers to consider when they meet at this week’s FOMC meeting. Prior to the loss of confidence in US regional banks, Fed Chair Powell had signalled that the Fed was considering raising rates to a higher peak and returning to larger 50bps hikes. The recent sharp tightening in financial conditions though means that a larger 50bps hike should be off the table again as policy option at this week’s FOMC meeting. If financial market conditions deteriorate further in the run up to the meeting, it would not be surprising if the Fed chose to delay plans to raise rates further. While stronger US activity and inflation data at the start of this year still favour further Fed rate hikes, the Fed may decide that there is little risk in waiting until the next policy meeting on 3rd May before raising rates again. The Fed has already raised rates into more restrictive territory at around 4.6%, and they could send a strong hawkish signal that they still plan to raise rates further to bring down inflation dependent of course on confidence returning to the US banks. A decision to delay rate hikes this week would pose further downside risks for the USD in the week ahead. The US rate market has already scaled back terminal rate hike expectations for the Fed to a peak of around 4.8% compared to a peak of around 5.6% prior to SVB’s collapse. The Fed runs the risk of encouraging US rate market participants to become more confident in pricing in the next move being a rate cut if they delay hiking this week. 

In these circumstances, we continue to expect further downside for the USD in the near-term especially against the JPY. The JPY should still outperform the USD even if risk aversion intensifies and provides more support for the USD broadly. Furthermore, the release at the end of last week of the stronger Shunto wage agreements for Japan will reinforce speculative demand for the JPY in anticipation that the BoJ will shift away from current loose policy settings under new Governor Ueda. We would argue though that the likelihood of a more immediate shift in BoJ policy when new Governor Ueda takes over next month will diminish if current more challenging financial market conditions persist. Please see our latest FX Weekly for more details (click here).    

KEY RELEASES AND EVENTS

Country	GMT	Indicator/Event	Period	Consensus	Previous	Mkt Moving
EC	10:00	Trade Balance	Jan	-12.5B	-8.8B	!!
EC	14:00	ECB President Lagarde Speaks	--	--	--	!!!
EC	16:00	ECB President Lagarde Speaks	--	--	--	!!!