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FX Update: Waiting game for next shoe to drop.

Forex
Picture of John Hardy
John Hardy

Head of FX Strategy

Summary:  Markets are maintaining a nervous calm, as we avoided banking-system drama at the weekend for the first time in three weeks. But even if we avoid further systemic risks in the financial system for now, tightening credit conditions have brought recession risks sharply forward. FX has navigated the recent market turmoil with considerable churn and little conviction on where this leads. The economic data calendar this week, meanwhile, is a light one.


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Today's Global Market Quick Take: Europe from the Saxo Strategy Team

FX Trading focus: Systemic pressures remain a focus in near term, but eventual next shoe to drop will be the economy as recent turmoil has brought the recession sharply forward.

Even as the turmoil that US banks and eventually global banks and wider sentiment remains in focus and a soft spot, markets managed to bounce into the close on Friday, with yields pulling back from cycle lows in the US following through into the European morning today, with yields continuing to bounce, but the bank-related assets like Tier1 debt and banks stocks struggling after a rally attempt, as noted in the EURUSD comments below. Looking ahead at the calendar for this week is hardly inspiring, though we do get some timely Germany and EU March inflation data on Thursday and Friday and less timely US inflation data, the February PCE inflation data, on Friday. Tomorrow, we get a look at the March US Consumer Confidence survey, a bit more interesting than usual for a measure on whether the situation is impacting US confidence more broadly, but also as the February Expectations-Present Situation hit its lowest level, at -83.1, for the cycle and since 2001 (in fact, since the initiation of the survey in the 1960’s, it has only been worse than that February reading in a cluster of three months back in early 2001.)

The optimists, and perhaps the USD bears, would point out that we are already seeing vastly easier monetary conditions, as the removal of expectations for Fed hikes and the general mark-down of the entire US treasury yield curve is a net easing of financial conditions, and as the Fed’s recent backstopping moves have seen its balance sheet suddenly balloon nearly $400 billion, wiping away months of QT. On the other hand, the growth in the Fed’s balance sheet is chiefly a reflection of commercial bank balance sheet pressures as banks access the expensive discount window (relative to near zero-interest bearing standard deposits) and BTFP facility. And high yield corporate credit spreads are also at local highs, well above 500 basis points as of Friday’s close. History often shows us (in 2001-02 and then again in 2007-09) that the worst market outcomes are in the phase of the yield curve steepening aggressively as yields are bracing for the incoming recession and as the recession starts to play out, with sentiment usually bottoming long after policymakers have . We’re very early in this process – now better able to get a handle on the recession having now been brought sharply forward by this latest turmoil and tightening credit conditions, but with hardly any signs of a softening economy.

Elsewhere, the lack of the Japanese yen’s ability to catch a firmer bid on the latest interest rate turmoil is noteworthy, but does suggest that we need to see a more determined fall in yields – and one that is combined with broader sentiment hitting the skids – for the JPY to sustain a rally. Still, the JPY bears watching as the Japanese financial year draws to a close those Friday and as Governor Kuroda rides off into the sunset next week, with Kazuo Ueda set to take the reins.

Chart: EURUSD
EURUSD is a decent barometer for where we are with the US dollar. The upside was tamed by the sense that many of the same dynamics that have US banks under pressure also plague European banks, as seen in share prices still under pressure and in very high yields on banks’ Tier 1 bonds after the SNB wiped out Credit Suisse Tier 1 bond debt holders in the USB takeover deal and despite EU assurances that Tier 1 debt ranks higher than common equity in the capital structure. The high yields on Tier 1 bonds suggest that EU banks should be issuing equity, a dilution risk that has investors still treating European bank shares with extreme caution this morning, with a significant morning bounce largely wiped away as of this writing. Alas, for FX investors, the general lack of wider systemic contagion despite the intense focus on banks means that FX is struggling for inspiration. After the sprint higher to 1.0930, the pair traded in the low 1.0700’s on Friday, and it appears the 1.0700-50 is the downside swing zone, with more risk contagion likely needed to get the greenback firmly back on top of the single currency.

27_03_2023_JJH_Update_01
Source: Saxo Group

Table: FX Board of G10 and CNH trend evolution and strength.
Odd companions at the top of the trending table are the yen, which got a solid bump from the recent downshift in global yields and sterling, where got a minor upgrade in BoE rhetoric on defending against inflation risks, but not much else. The laggards are AUD, NZD and CAD as the China re-opening story has struggled for confirmation in markets and as oil prices remain mired near 1-year lows.

27_03_2023_JJH_Update_02
Source: Bloomberg and Saxo Group

Table: FX Board Trend Scoreboard for individual pairs.
Momentum has come out of recent developments like a potential EURSEK downtrend, where there is also concern on Sweden’s financial system. JPY crosses are all in negative trend status, but many are very choppy and not particularly compelling, including the likes of EURJPY and GBPJPY.

Upcoming Economic Calendar Highlights

  • 1430 – US Mar. Dallas Fed Manufacturing Activity
  • 1700 – US 2-year Treasury Auction
  • 1700 – UK Bank of England Governor Bailey to speak
  • 2100 – US Fed’s Jefferson (voter) to speak

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