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GBP
With everything else going on, it may have escaped the attention that yesterday also saw the UK’s most important fiscal showpiece of the year. We are of course referring to the Spring Budget, which was delivered in Parliament just after midday. Expectations leading up to the event were for the Chancellor, Jeremy Hunt, to play with a straight bat and avoid doing much that would move markets. He needn’t have worried. With markets more concerned over the stability of the banking system, and sterling moving wildly as a result, tweaks to UK tax and spending were an afterthought. Despite this, Hunt stuck to the anticipated playbook with the statement revealing little new information regarding the government’s plans, helped in large part by the leaking of almost every upcoming measure to news outlets prior to the event. In this context, it was the new set of forecasts by the OBR that caught the attention, suggesting that the UK would avoid a technical recession in 2023. Whilst the UK economy is still expected to shrink by 0.2% this year, it marks a notable upgrade to the short term outlook for the UK economy and was accompanied by a projection for inflation to fall to just 2.9% by year-end. With the next Bank of England monetary policy decision just around the corner, this mix of more robust growth and rapidly falling inflation looks like good news for the MPC. However, Bank forecasts, including those from the February Monetary Policy Report, have been markedly more bearish than those from the OBR in recent times. With inflation continuing to remain high for now, markets will be looking to see how the Bank chooses to balance its more pessimistic outlook for the economy against rising financial stability risks at the upcoming meeting. Our expectation as of now remains a final 25bp hike, but this view could evolve over coming days if more uncertainty around the banking system emerges, with the risk now titled towards a hold in rates under this scenario.
EUR
European banking stocks fell 7.15% on aggregate yesterday, with losses exceeding 10% in flagship names such as Société Générale and BNP Paribas. Amid the turmoil within European banking stocks, triggered by a nosedive in Credit Suisse’s stock price, markets once again priced out expectations that the ECB could hike aggressively at today’s meeting and could continue over the next few meetings. Price action in the German two-year yield reflected this as it fell the most in decades, while the implied probability of a 50bp hike today in overnight index swaps fell to just 14%.
Although markets have become a bit more hawkish in early trading today, with swap markets suggesting the decision over a 25bp and a 50bp hike is now a coin flip, we think ultimately the decision is to either hold rates completely or to hike by 50bps. Should the ECB deem the volatility in the market backdrop too elevated to hike 50bps as planned, dropping down to a 25bp hike would suggest their inflation target is a lesser priority. Instead, we think holding rates and signalling a resumption of their tightening cycle at a later date once market conditions have stabilised, whether at a scheduled or unscheduled meeting, would be an easier message for them to convey. Comparatively, we think with the European banking sector better capitalised and regulated than in the US and with the ECB’s deposit rate starting from a lower base, the ECB should have the flexibility to fulfil its prior guidance and hike 50bps today. Instead, we expect the recent arrival of financial stability risks to manifest in the ECB’s forward guidance. This will likely result in President Lagarde stressing data-dependence and a meeting-by-meeting approach while also emphasising that the ECB is remaining vigilant to any financial stability risks within the eurozone system. Whereas previously, forward guidance was likely to take the form of the central bank’s perceived sensitivity to a stronger core inflation profile. What a 50bp hike means for the euro in this context largely depends on how banking stocks continue to perform in today’s cash trading. A rebound, which looks most likely given how Credit Suisse’s stock price has opened this morning, means a 50bp hike from the ECB would instil greater confidence in the eurozone financial system, which would be euro supportive. However, if the ECB doesn’t get its timing right or Lagarde produces a communication blunder, today’s meeting could soon weigh heavy on the single currency. All will be revealed at 13:15 GMT and 13:45 GMT respectively.
USD
There are three similarities between Silicon Valley Bank and Credit Suisse. Firstly, they’re both headquartered in regions where there are snow-capped peaks. Secondly, their stock prices are both reflecting the consequences of poor governance. Thirdly the sudden decline in their market values has raised concerns over financial stability. The main difference, however, is that in the US, the size of SVB meant it was easier to contain the market fallout from it being put into receivership. Meanwhile, with over four times the number of assets and thus a much greater presence in global financial markets, the decline in Credit Suisse poses significant risks of systemic financial instability. That is why yesterday’s session, where Credit Suisse’s stock plunged over 24% on the day, was much more concerning from the standpoint of global financial stability and resulted in European bank stocks losing a staggering $60bn in combined market value. The risk of more systemic financial instability resulted in markets behaving in a more traditional manner: global equities were down, front-end yields fell, credit default swaps rallied, and currency traders took refuge in the dollar, Japanese yen, and dollar funding markets. European currencies led losses against the greenback, with the euro notably down 1.65% on the session as one of the hot trades of the year, long European banks, was dramatically wound down.
Just like on Tuesday, however, the start of today’s session looks a bit calmer. This follows a joint announcement from Swiss regulator FINMA and the Swiss National Bank last night, which didn’t just show support for the bank’s financials but also offered to backstop its liquidity if needed. This morning, Credit Suisse announced that they will take up the SNB’s offer and will borrow up to CHF50bn, while also buying back some senior debt securities. Whether or not this will stem the overall flight from bank stocks and result in an easing in financial stability concerns is yet to be seen, however, this morning Credit Suisse’s stock price is up over 30% following the announced measures. Nonetheless, the overall level of volatility within the cross asset space warrants continued caution by investors. While in the FX space we will once again be watching how the stock market performs, today we will also have one eye on the sensitivity of central banks to the financial stability risks as the ECB is set to announce its latest policy decision.
CAD
The Credit Suisse news dominated the headlines, leading markets to trade in risk-off fashion. As a risk-off environment does not bode well for the loonie, the currency’s fortunes were less than stellar yesterday: it fell -0.6% against the greenback. But Credit Suisse wasn’t the only reason for CAD weakness—the price of crude oil is tanking. Crude prices have fallen in 6 of the last 7 trading days, with the daily losses growing in size. Yesterday, WTI broke below $66, but it was over $80 just a week ago and trading comfortably in the upper-70s prior to that. Much of the oil sell-off is being driven by the same banking story that’s causing risk-off everywhere, but part of it stems from the fact that Russia has not cut back on production, despite promising that it would. Canada wholesale sales are scheduled for release on today’s calendar, but given the current state of affairs, news stories about banks and potential bailouts will continue to be the number one driver for markets.
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