Dollar Soft as SVB Continues to Roil Markets

March 13, 2023
  • Markets remain jittery as financial stability concerns remain at the forefront; Fed expectations have downshifted sharply in the wake of the SVB failure
  • ECB tightening expectations have fallen; HSBC will buy the U.K. arm of SVB for one pound; BOE tightening expectations have fallen nonetheless
  • Japan reported weak Q1 BSI business conditions

The dollar remains soft as SVB continues to roil markets. DXY is down for the third straight day and trading near 104.201 after trading at the lowest since February 16 near 103.732 earlier today. We believe this weakness is overdone as Fed tightening expectations should eventually recover. The euro is trading higher near $1.0670 while sterling is trading higher near $1.2055 but we believe these moves are not sustainable. USD/JPY traded at the lowest since February 15 just below 133 earlier today but has recovered slightly to around 133.55. For now, the SVB fallout continues to trump the stronger than expected U.S. data but that simply cannot continue. Tomorrow’s CPI data will likely test the current weak dollar trade.

AMERICAS

Markets remain jittery as financial stability concerns remain at the forefront. Despite the raft of measures announced by U.S. policymakers over the weekend that were designed to address these concerns, equity markets remain under pressure, led by financials, while U.S. Treasury yields have plummeted. This has taken a toll on the dollar, which really should be benefiting from a safe haven bid. When markets finally calm, we expect these trades to unwind.

Fed expectations have downshifted sharply in the wake of the SVB failure. We couldn’t disagree more. We do not think SVB impacts Fed policy whatsoever; while financial stability is the Fed’s unofficial third mandate, we believe the inflation fight continues to take precedence. Yes, U.S. policymakers will continue to take actions to limit the fallout but lower interest rates are not the solution. We believe that the SVB failure is a direct consequence of years of easy money. Going back to that is not the right solution and markets need to brace for continued tightening of monetary policy. WIRP suggests a 25 bp hike March 22 is only around 80% priced in, while odds of a larger 50 bp move have been price out from over 70% pre-SVB. A 25 bp hike May 3 is no longer priced in, while two 25 bp cuts are nearly priced in by year-end that would take the Fed Funds target range down to 4.25-4.5%. That would be below the current range of 4.5-4.75% and that is simply not going to happen.

EUROPE/MIDDLE EAST/AFRICA

European Central Bank tightening expectations have fallen. This comes despite the hawkish digging in their heels. Holzmann said he wants 50 bp hikes at every meeting through July, which would take the deposit rate up to 4.5%. His comments come ahead of the ECB decision this Thursday when the bank is expected to hike the deposit rate 50 bp to 3.0%. At this point, the only debate is what its forward guidance will be as the hawks and the doves slug it out. As things stand, WIRP suggests odds of a 50 bp hike this week have fallen below 65% after being fully priced in last week. A 25 bp hike May 4 is priced in, while one more 25 bp hike is priced in for September or October that takes the deposit rate up to 3.5% down from 4.0% last week.

HSBC will buy the U.K. arm of SVB for one pound. This comes after emergency meetings were held over the weekend by Prime Minister Rishi Sunak, Bank of England Governor Andrew Bailey and City Minister Andrew Griffith. HSBC CEO Noel Quinn said that the acquisition makes strategic sense as it boosts the bank’s exposure to the technology and life-science sectors. The Bank of England said that “all depositors’ money with SVB UK is safe and secure as a result of this transaction” and added that all SVB services “will continue to operate as normal and customers should not notice any changes” and that “no other UK banks are directly materially affected by these actions.” SVB UK staff will remain employed and the bank will continue to be authorized by UK regulators.

BOE tightening expectations have fallen nonetheless. WIRP suggests a 25 bp hike March 23 is only 75% priced in after being fully priced in last week, while a 25 bp hike May 11 is only about 25% priced in. That final 25 bp hike is nearly priced in that would see the policy rate peak near 4.5%, down from 4.75% last week. Dhingra speaks later today. She has emerged as the leading dove on the MPC so expect dovish comments to hit the tapes.

ASIA

Japan reported weak Q1 BSI business conditions. Large all industry reading came in at -3.0 vs. 0.7 in Q4, while large manufacturing came in at -10.5 vs. -3.6 in Q4. The manufacturing reading is the weakest since Q2 2014, while the all-industry reading is the weakest since Q1 2022. The report is just the latest in a series of weak economic data and supports the Bank of Japan’s cautious stance. WIRP suggests around 20% odds of liftoff April 28, rising to around 33% June 16 and then nearly 66% for July 28. In addition, the actual tightening path is seen as very mild as the market is pricing in only 10 bp of tightening over the next 12 months followed by only 25 bp more over the subsequent 24 months. That is why we expect any knee-jerk drop in USD/JPY after liftoff to be fairly limited. For now, the pair is trading lower on risk off impulses and a break below 132.90 would set up a test of the February 10 low near 129.80.

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