Dollar Firm as Risk Off Impulses Boost Safe Havens

April 25, 2023
  • Risk off impulses are picking up; no wonder the Swiss franc continues to outperform; yet the major central banks pared back emergency dollar funding settings; troubled regional bank First Republic held its earnings call after the close yesterday and it wasn’t pretty; March Chicago Fed National Activity Index is worth discussing
  • ECB officials remain hawkish; U.K. reported March public sector net borrowing data; BOE Deputy Governor Broadbent defended the bank’s policies; Hungary is expected to keep the base rate steady at 13.0%.
  • BOJ Governor Ueda signaled no imminent change in monetary policy as he appeared before parliament; Korea reported Q1 GDP data; iron ore prices continue to sink

The dollar is firm as risk off impulses pick up. DXY is trading higher for the first day near 101.467 after three straight down days. The yen and Swissie are also outperforming while the euro is trading lower near $1.10 and sterling is trading lower near $1.2475. USD/JPY is trading heavy near 134 while USD/CHF is testing the recent cycle low near 0.8860. The dollar smile remains in place as last week’s gains on the back of rising U.S. yields has been replaced by the safe haven bid. We believe this environment favors further dollar strength.

AMERICAS

Risk off impulses are picking up. Global equity markets are down, global bond yields are down, and the safe haven currencies are up. The ostensible trigger was the Frist Republic earnings call that took place yesterday after U.S. markets closed (see below). As we have long warned, banking sector concerns are unlikely to go away until there has been a resolution with regards to First Republic. That call served as a stark reminder that its fate remains very much up in the air.

No wonder the Swiss franc continues to outperform. It is the top major performer YTD due in large part to a safe haven bid in the wake of banking sector turmoil. With the ongoing lack of a resolution yet for First Republic, CHF is likely to remain firm. EUR/CHF could test the March low near 0.97 while USD/CHF is about to break below the March low and test the January 2021 low near 0.9535. Risk off sentiment is largely transitory and so and when these banking sector concerns fade, we think EUR/CHF will move back above 1.0 and USD/CHF will move back towards 0.94, which are the early March pre-SVB levels. Short-term, further CHF seems likely. Of note, CHF/JPY is trading near 152 at levels not seen since 1980. In the battle of the havens, CHF is coming out on top for now.

Yet the major central banks pared back emergency dollar funding settings. Perhaps the timing left a bit to be desired but the joint statement read that “In view of the improvements in US dollar funding conditions and the low demand at recent US dollar liquidity-providing operations, the Bank of England, the Bank of Japan, the European Central Bank and the Swiss National Bank, in consultation with the Federal Reserve, have jointly decided to revert the frequency of their 7-day operations from daily to once per week.” The frequency of the funding operations was increased to daily back on March 19 in response to the banking sector turmoil and the return to weekly operations will being May 1. Lack of demand was the reason for moving back to weekly operations but the statement added that “These central banks stand ready to re-adjust the provision of US dollar liquidity as warranted by market conditions.”

Troubled regional bank First Republic held its earnings call after the close yesterday and it wasn’t pretty. Deposits fell by nearly half to $104.5 bln at the end of Q1 vs. $136.7 bln expected, and tacked another 1.7% drop in Q2 through April 21. The large Q1 drop is even more noteworthy since First Republic got a $30 bln injection of deposits from 11 of the largest U.S. banks in March. The bank said it continues to explore strategic options even as it works to restructure its balance sheet and reduce expenses. To that end, the bank plans 20-25% cut in its workforce in Q2. Most importantly, it withdrew all previous financial guidance and refused to take any questions. Of note, the bank said it is moderating loan volumes. 

March Chicago Fed National Activity Index is worth discussing. Headline came in at -0.19 vs. -0.20 expected and -0.19 in February. The 3-month moving average improved to 0.01 vs. -0.09 in February and is the highest since October. Recall that when that 3-month average moves below -0.7, that signals imminent recession and we are still well above that threshold. This series has taken on greater significance now that the 3-month to 10-year curve has inverted deeply. The continued resilience in the economy is noteworthy and suggests the Fed still has a lot more work to do in getting to the desired sub-trend growth. We also thinks it underscores just how much markets are underestimating the Fed's need to tighten.

This suggests some upside risks to Q1 GDP Thursday. Consensus currently is at 2.0% SAAR vs. 2.6% in Q4. Of note, the Atlanta Fed’s GDPNow model is currently tracking Q1 growth at 2.5% SAAR. Next and final model update for Q1 will come tomorrow. After that, the model will start tracking Q2. The mix of Q1 growth will be important. In Q4, the bulk of growth came from inventories while personal consumption and net exports slowed.

Regional Fed surveys for April continue to roll out. Philadelphia Fed non-manufacturing, Richmond Fed manufacturing (-8 expected vs. -5 in March), and Dallas Fed services indices will be reported today. So far, the manufacturing surveys have been mixed. Dallas Fed manufacturing index came in -23.4 vs. -12.0 expected and -15.7 in March, Philly Fed came in at -31.3 vs. -19.3 expected and -23.2 in March, and Empire survey came in at 10.8 vs. -18.0 expected and -24.6 in March.

Housing data is expected to show ongoing weakness. February FHFA and S&P CoreLogic house price indices and March new homes sales (-1.3% m/m expected) will be reported. Pending home sales will be reported Thursday and are expected at 0.7% m/m vs. 0.8% in February.

April Conference Board consumer confidence will also be reported. Headline is expected to fall two ticks to 104.0.

EUROPE/MIDDLE EAST/AFRICA

ECB officials remain hawkish. Schnabel said “Data dependence means that 50 bp are not off the table,” adding that “we are going to look at all the available data at that point in time. The data we have so far shows that inflation is higher and the economy more resilient than projected.” Chief Economist Lane said “The current data are indicating that we should raise rates again. This is still not the right time to stop. Beyond that, I don’t have a crystal ball; it will depend on the economic data.” However, Lane did not specify how much the bank should hike. The next policy meeting is May 4 and WIRP suggests nearly 33% odds of a 50 bp hike then. After that, another 25 bp hike is priced in for June 15 followed by another hike July 27. Odds of one final hike in in September or October top out near 45% and so the peak policy rate is now seen between 3.75-4.0%, up from3.75% at the start of last week and 3.50% at the start of the week before that.

U.K. reported March public sector net borrowing data. Ex-banking groups came in at GBP21.5 bln vs. GBP21.3 bln expected and a revised GBP13.5 bln (was GBP16.7 bln) in February. This is the largest since March 2021 and reverses the recent improvement. If this continues to worsen, Chancellor Hunt may have to rethink plans to deliver some fiscal largesse ahead of likely elections in autumn 2024. Say tuned. Elsewhere, CBI released the results of its April industrial trends survey. Total orders came in at -20 vs. -21 expected and -20 in March, selling prices came in at 23 vs. 20 expected and 25 in March, and business optimism came in at -2 vs. -5 in March. Distributive trades survey will be reported Thursday, with retailing reported sales expected at 4 vs. 1 in March..

BOE Deputy Governor Broadbent defended the bank’s policies. Specifically, he said that the BOE’s QE program during the pandemic was not responsible for current high inflation shock. Broadbent noted that “QE inevitably leads to rapid growth of commercial bank deposits … and that this, in turn, inevitably leads to excessive inflation are not well supported by the evidence.” He added that it was “difficult to see these additional deposits as the principal cause of the inflation that’s followed” and that “very large jumps” in import prices such as energy, “seem the more likely cause.” We concur. Massive waves of QE in the wake of the financial crisis and then the eurozone crisis did not spark inflation.

That said, the BOE remains behind the curve as inflation remains stubbornly high. The next policy meeting is May 11 and WIRP suggests a 25 bp hike is fully priced in, with only 10% odds of a larger move. Another 25 bp hike June 22 is around 80% priced, while odds of one last 25 bp hike top out near 75% for September 21 and so the peak policy rate is seen near 5.0% vs. 4.75% at the start of last week and between 4.50-4.75% at the start of the week before that.

National Bank of Hungary is expected to keep the base rate steady at 13.0%. At the last policy meeting March 28, the bank kept the base rate unchanged and said that it would keep the more important 1-day deposit rate steady at 18% until it sees a “trend-like improvement” in Hungary’s inflation outlook. Inflation remains stubbornly high and well above the 2-4% target range and so any thoughts of an easing cycle anytime soon seem misguided.

ASIA

Bank of Japan Governor Ueda signaled no imminent change in monetary policy as he appeared before parliament. Specifically, he said the bank should continue monetary easing with Yield Curve Control given current economic conditions. Ueda noted that the shape of the yield curve is smooth now after the recent drop in global bond yields but will keep watching how financial markets function. He said the bank will take the appropriate steps to tighten if wages or inflation rise more than expected and policy changes become necessary. Ueda’s comments come just before the start of the April 27-28 meeting and support our view that the bank will not make any policy changes in his first meeting.

Korea reported Q1 GDP data. Growth came in a tick higher than expected at 0.3% q/q vs. -0.4% in Q4, while the y/y rate came in a tick lower than expected at 0.8% y/y vs. 1.3% in Q4. This was the weakest y/y rate since Q4 2020. March IP will be reported Friday and is expected at -10.3% y/y vs. -8.1% in February. If so, it would be the sixth straight monthly contraction. Clearly, China reopening has had little impact on the economy. Bank of Korea has kept rates steady for two straight meetings but has called it a pause. If the economy continues to weaken, we think the tightening cycle may have ended. Next policy meeting is May 25 and rates are likely to be kept steady again at 3.5%.

COMMODITIES

Iron ore prices continue to sink. It just broke below the 200-day moving average near $106.70 and is on track to test the late November low near $90.10. After that, there aren’t any major chart points until the October low near $74.65. Normalized so that China reopening is equal to 100, iron ore prices are now below the level that prevailed then, as are coal prices. These are two of Australia’s biggest exports to China and so further weakness here should weigh on AUD, with along with NZD and NOK are the worst major performers YTD. . Copper and oil and given up most of their post-reopening gains but are still up slightly.

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