Spectrum FX Daily Report

A sense of calm has returned, as investors believe that the fallout will be contained, and that the recent failures were driven more by one-off factors, rather than systemic issues. A number of central bankers have attempted to calm market participants so far this week, which appears to have been successful, at least to some extent. Federal Reserve vice chairman for supervision Michael Barr stated on Monday that the collapse of Silicon Valley Bank was a result of ‘terrible’ risk management, while Bank of England governor Andrew Bailey indicated that the UK financial system was ‘resilient’ and ‘liquid’, and that the turmoil would not derail further rate hikes.

The result has been a ‘risk on’ mode in financial markets, characterised by a rebound in equity markets and government bond yields, and a retracement in the safe-haven currencies. In the US, the S&P 500 index is now roughly unchanged for the month, while in Europe, the DAX index is currently trading only modestly below its early-March levels. In FX, the Japanese yen, which has re-emerged as the world’s chief safe-haven currency since the start of the banking headlines, has retreated from its near-eight week highs, while the higher risk major currencies have generally performed quite well, led in the past week by the Norwegian krone.

Among the G3 currencies, sterling has outperformed, extending its month to date gains to more than 2% against the dollar on Wednesday. Unlike in Europe, fears surrounding the possible failure of UK banks have been remarkably contained, and the recent episode doesn’t appear likely to have a particularly significant impact on BoE monetary policy. Meanwhile, the common currency has rallied back above the $1.08 level, albeit the euro has lagged behind most other major currencies, in part due to the concentration of the lingering banking risk in the European continent. The same can be said for the Swiss franc, which has remained at the foot of the G10 FX performance tracker since the Credit Suisse headlines first hit the newswires.

We contest that markets are not entirely out of the woods just yet, and that investors still remain somewhat on edge, despite the relative calm. Much will now depend on the extent of the pending contraction in credit in the coming weeks, particularly in the US. Fed chair Powell warned during last week’s FOMC meeting that this credit tightening could act to prevent further US rate hikes, and investors subsequently see a higher probability of no change than another hike at the next Fed meeting. This afternoon’s revised Q4 US GDP data is unlikely to change these expectations too much, although Friday’s PCE data, the Fed’s preferred measure of inflation, may well do. As far as EUR/USD is concerned, we suspect that Friday morning’s Euro Area inflation data will take on more importance. An easing in the headline print is expected, although the key will be the core inflation number, which is expected to take another leg higher.

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