Sovereign International Daily Market Report
How has the SVB collapse impacted the FX market?
Summary:
The collapse of Silicon Valley Bank in the US, which went under last week following a period of gross interest rate risk mismanagement, has sent ripple effects throughout financial markets in the past few days.
Equity markets collapsed globally late-last week on the news of the largest US bank failure since Lehman Brothers in 2008. The S&P 500 index was down more than 4% at one stage, while share indices in Europe were lower by a similar amount. Amid fears of contagion and systemic risk within the US banking sector, investors have favoured the safe-haven currencies in the past few trading sessions, at the expense of higher-risk emerging market ones. The chief beneficiary of the move has been the Swiss franc, which is up around 3% on the dollar in the past week, followed not too far behind by the Japanese yen.
As far as currency markets are concerned, the main impact of the SVB fallout has been on interest rates, and central bank rate expectations. Markets are betting that the Federal Reserve may have to halt, or end altogether, its interest rate hike cycle, for fear that other major banks follow suit. At one stage on Monday, investors had completely discounted the possibility of any more US rate hikes, and remarkably were pricing in rate cuts as soon as the July FOMC meeting. US Treasury yields had also collapsed, particularly short-term rates, with the 2-year yield tanking by approximately 80bps in just two days - indeed it notched its largest one-day drop since “Black Monday” in 1987, exceeded moves following 9/11 and the 08/09 crash.
Since then, we’ve seen somewhat of a normalisation in markets, as logic and calm take over from the panicky moves witnessed at the beginning of the week. The dollar has stabilised against its peers, while the 2-year Treasury yield has risen around 50bps off its lows to back around the 4.4% mark. On Monday, futures markets were pricing in multiple US rate cuts by year-end, although this has since been reversed. Clearly, the fed funds rate is now almost certain to end lower this year than anticipated prior to the recent turmoil, but we believe that an abrupt end to hikes would be an unwise and counterproductive move, as this would likely ramp up concerns of contagion within financial markets. We are instead pencilling in another 25bp hike at the Fed’s March meeting, combined with diluted guidance that indicates an entirely wait-and-see approach and a stance almost entirely dependent on the fallout in financial markets.
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The more pressing issue will be the response of the European Central Bank, which will be convening for its latest policy meeting on Thursday. As we mentioned in our ECB preview report, we think that the impact of the SVB fallout on Europe is limited, and that another 50bp hike, as telegraphed in February, is still likely on the way. Interest rate markets had lowered their expectations for hikes across the board earlier in the week, including in Europe, although investors seem to be back on board with a 50bp move, which is now almost fully priced in again. The key to the euro reaction will be the communications on rates beyond then. Given the uncertainty in financial markets, we think that we’ll see watered down forward guidance, and an approach that is almost entirely data-dependent.
In the midst of the aforementioned turmoil in markets, sterling has performed rather well, appreciating by almost 3% on the dollar in the past week. In the G10, the change in rate expectations in the UK has been among the least aggressive, albeit far from negligible, which has partly led to this pound outperformance. As thing stand, markets are still pricing in another 25bp hike from the Bank of England next week, although not fully (around 70%). In light of recent strength in UK economic data, we think that a 25bp move is still likely, so there is a bit of room for more upside in sterling. Today’s UK budget announcement will also be closely watched by markets, although most of details have already been released, including the extension to the Energy Price Guarantee scheme through June.
Market Report provided by Ebury
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