Head of FX Strategy
Summary: The market is having a hard time grappling with the backdrop of wild bond market volatility, but the JPY has reset higher, if still trading choppily after the weekend’s SNB-arranged UBS takeover of Credit Suisse raised as many questions as it answered. The US dollar is selling off today in Europe as sentiment rebounds and as participants suspect that the Fed will have to err on the side of caution at this Wednesday’s FOMC meeting.
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Today's Global Market Quick Take: Europe from the Saxo Strategy Team
FX Trading focus: JPY blasts out of gates on yield drop, but the currency remains choppy as market struggles to draw conclusions. The US dollar is well off its lows as the market has dramatically repriced the Fed’s forward policy curve and
The market initially tried to put a brave face on the weekend’s SNB-arranged takeover of Credit Suisse by UBS, with sentiment strong and the USD and JPY weak. But this quickly yielded to risk off and sharp JPY rally and another big drop in global bond yields. Unease remains and the specifically unsettling story was the wipeout of Credit Suisse’s Tier1 debt, which saw further negative focus on banks overnight and into early European trading today on the unprecedented move. But by the lunch hour today, yields in Europe are rebounding and the JPY strength had eased somewhat. More on the relative euro- and JPY moves in the chart below. There was no strong signal on the USD ahead of this Wednesday’s FOMC meeting – more on that below.
Chart: EURJPY
EURJPY was marked sharply lower as the crumpling yields supported the JPY overnight once again, while the SNB-arranged wipeout of Credit Suisse’s Tier1 debt in its sale to UBS unsettled the huge market for similar bonds from European banks. As yields recovered today from new lows and EU regulators are out trying to reassure that Tier1 debt ranks above common equity in the capital structure, the euro is recovering today and the JPY strength if fading. As well, the JPY has traditionally proven more sensitive to longer yields, which have retreated far less as yield curves steepen. The interpretation of the latter could be that central bank may have to ease soon because of the damage from this tightening cycle to financial conditions, but that will also mean that they are more likely to fail in their fight against inflation – this is far less JPY-positive than would be the case had we seen a stronger move lower in long yields, which would suggest a higher risk of a more traditional deflationary economic slowdown. From here, we’ll be watching global longer bond yields as the key coincident indicator and the 200-day moving average near 141.80 to the upside an the range lows near 137.50 to the downside if we are set for a more significant capitulation.
FOMC faces a tough task at its meeting this Wednesday.
The Fed has finally succeeded in “breaking something” with its tightening cycle, but it wasn’t inflation or the economy in the first instance, but rather the weaker links in the global financial system. And with funding costs now much higher, contagion risks remain, all while the fight against inflation has yet to have been won. Worst for the Fed, there is no policy path from here that works to both ease financial conditions but continue the fight against inflation. What does the Fed then do? It’s important to recognize that the market has already shifted hard for expecting significant rate cuts for the next 12 months. The forward expectations have suffered what can only be described as a seizure, with the December Fed Funds future pricing a policy rate near 3.75%, about 180 bps below where they eight trading days ago.
At Wednesday’s FOMC meeting, therefore, assuming markets are more or less where they are now and not in some new panic mode, the Fed may either pause or possibly hike one last time for now by 25 basis points to pretend that it isn’t panicking, while providing less certain guidance on the policy path from here. The more interesting question and message in their guidance will be in the accompanying materials and “dot plot” forecasts. Will the Fed be willing to mark the end-2024 forecast at anything resembling the 3% it currently trades? The December dot plot had the Fed median forecast over 100 basis points higher at 4.00-4.25%. Still, whatever the Fed says or delivers, the market may be happy to thumb its nose at Fed guidance at this stage after the recent earthquake in rates that few saw coming, least of all the Fed.
Credit Suisse’s demise and shotgun wedding this weekend were not directly linked to the tightening cycle, but to its troubled past (Greensill and Archegos debacles are two prominent examples) and an accelerating drain in counterparty confidence. That latter factor is where we find the similarity with the US’ SVB: it’s depositor base abandoning ship. It is this dynamic that presents an ongoing risk to weaker players in the banking system and driving further contagion across all banks if depositors decide that their capital is better off placed in government bonds or even in equities or gold or crypto. Yes, the SVB and Credit Suisse examples remind us that the authorities will always step in last minute to prevent any specific situation from going systemic. But the pressure on liquidity and credit transmission from all of this will bring forward the next recession as the credit cycle is making a decisive turn for the worse here.
Table: FX Board of G10 and CNH trend evolution and strength.
Gold has soared at what would seem an unsustainable pace unless we are set for a systemic event. The most likely route to a bout of consolidation would be a rebound in yields and a Fed that moves ahead with a 25-bp hike and continues its inflation focus, while pointing to other approaches if turmoil persists. Note the JPY strength, but also the relatively sideways USD despite the market turmoil. First of all, risk sentiment this time around looks very different from cycles past (relatively firm equities) and because the Fed was one of the most aggressive policy tighteners and has seen a larger reversal of its forward policy rate than almost all other central banks. Interesting to see the only modest negative interpretation for CHF from the Credit Suisse deal, given all of the government guarantees that accompanied it.
Table: FX Board Trend Scoreboard for individual pairs.
Individual pairs show a lot of cross currents, though the gold strength sticks out very clearly. The USD situation post-FOMC across a number of pairs will be in spotlight this week.
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