Dollar Soft as Eventful Week Begins

March 20, 2023
  • Markets remain jittery after weekend developments; Fed tightening expectations have fallen ahead of the FOMC decision Wednesday; market easing expectations have run wild because the media blackout has precluded any Fed speakers BOC tightening expectations have also been dragged lower
  • Markets are still digesting the announced deal for UBS to buy Credit Suisse for CHF3 bln; ECB tightening expectations have fallen significantly since last week’s decision; BOE tightening expectations have also fallen ahead of its decision Thursday
  • BOJ released its summary of opinions from the March 9-10 meeting; RBA Deputy Governor Kent said the nation’s banking system remains strong; Taiwan reported weak February export orders

The dollar remains soft as markets digest weekend developments. DXY is down for the third straight day and trading near 103.578. We believe that markets are underestimating the Fed’s capacity to tighten (see below0 and so the dollar should eventually recover. The euro is trading higher near $1.07 while sterling is trading higher just above near $1.22. USD/JPY traded near 130.55 today, the lowest since February 10. With the BOJ seen on hold for the foreseeable future and banking sector tensions eventually easing, we believe USD/JPY is a buy at current depressed levels. Bottom line: we expect the dollar rally to resume after this current bout of market turmoil fades and markets are one again able to focus on the fundamentals.


Markets remain jittery after weekend developments. Besides the UBS deal to take over Credit Suisse, the Fed along with five other central banks announced a coordinated move to boost liquidity in their existing USD swap arrangements. Closer to home, New York Community Bancorp has taken over most deposits and some loans of Signature Bank. The deal excluded $4 bln of Signature Bank’s deposits related to its digital banking business. One interesting aspect of the deal is that the FDIC gets equity appreciation rights of up to $300 mln in New York Community Bancorp stock. While these developments might help quell some concerns, we think First Republic likely remains under the microscope and until its situation has been resolved, markets are likely to remain extremely unsettled.

Fed tightening expectations have fallen ahead of the FOMC decision Wednesday. WIRP suggests only 60% odds of a 25 bp hike, rising to nearly 100% for the May 2-3 meeting. We believe the ECB showed the way forward and so the Fed should follow suit and hike rates despite ongoing tensions in the banking system. Only that one 25 bp hike is priced in, while three 25 bp rate cuts are still priced in by year-end. With inflation still running hot, we do not think an easing cycle will be seen this year. U.S. yields remain way too low and should eventually recover along with the dollar.

Market easing expectations have run wild because the media blackout has precluded any Fed speakers. Simply put, we do not know the extent to which market turmoil is impacting the rate hike debate. We will know more at Chair Powell’s press conference Wednesday afternoon. Our best guess is that Fed officials fall in line with ECB President Lagarde, who last week stressed that there is no trade-off between price and financial stability. This was a very strong statement that suggests any banking sector issues won't derail the tightening cycle. We think this view is held by pretty much every central bank, including the Fed, which supports our call for a 25 bp hike this week.

Bank of Canada tightening expectations have also been dragged lower. Next meeting is April 12 and WIRP suggests 25% odds of a cut then. Yes, a cut. While a pause might be warranted, a cut is not. Looking further ahead, three cuts are priced in total by year-end. Like the Fed, the BOC is highly unlikely to ease policy this year. Of note, it releases its summary of deliberations Wednesday for the March 8 meeting, when the bank paused as expected. While the bank said it was prepared to hike again if needed, the statement removed the reference to excess demand in the economy. The bank noted then that the latest data remain “in line with the bank’s expectation that CPI inflation will come down to around 3% in the middle of this year.” It added that “With weak economic growth for the next couple of quarters, pressures in product and labor markets are expected to ease.” Overall, the tone was on the dovish side and supported the pause.


Markets are still digesting the announced deal for UBS to buy Credit Suisse for CHF3 bln. Investors in Credit Suisse’s so-called Additional Tier 1 (AT1) bonds worth $17 bln were wiped out. What’s roiling markets is that equity investors were not wiped out and so took seniority over AT1 investors. Even though AT1 bonds are the lowest rung of bank debt, most assumed they had seniority over equity investors based on market conventions. This was upended by the UBS-CS deal but this seems to be an exception to the rule. Indeed, European regulators released a statement today reiterating that for banks outside Switzerland, AT1 bonds only take losses after equity investors have first been wiped out. Policymakers remain in full damage control mode.

European Central Bank tightening expectations have fallen significantly since last week’s decision. WIRP suggests less than 40% odds of a 25 bp hike May 4. Indeed, a 25 bp hike isn’t even priced in and top out at around 90% July 27 and so the deposit rate is likely to peak near 3.25%. There are plenty of ECB speakers this week and the hawks are likely to push back against the market’s dovish take on policy. Kazaks said “Inflation is still very high — rates, in my view, needed to go up. And if the baseline scenario holds and market volatility calms down and does not derail the scenario, then with the current macro outlook and the outlook for inflation, more interest-rate increases will be necessary.” While he is still way too hawkish, Kazaks is right to look through the current banking sector turmoil, which shouldn’t impact ECB policy. Centeno and Lagarde also speak today.

Bank of England tightening expectations have also fallen ahead of its decision Thursday. Here too, financial stability concerns should not impact policy. That said, tightening expectations have evaporated. WIRP suggests a 25 bp hike is 50-50. Indeed, a 25 bp hike isn’t even fully priced in and top out at around 90% June 22 and so the bank rate is likely to peak near 4.25%. Of note, sterling is the top performing major YTD but we simply cannot justify this from a fundamental perspective. Technically speaking, a clean break above $1.22 would set up a test of the January 23 high near $1.2450.


Bank of Japan released its summary of opinions from the March 9-10 meeting. Officials sounded cautious and one said that “The risk from a hasty policy change that could lead to missing a chance of such achievement should be considered as more significant than the risk from a delay in policy change.” On the other hand, one policymaker said it was necessary to pay “full attention” to upside inflation risks while another said higher-than-expected inflation may persist. Of note, Deputy Governors Himino and Uchida started their 5-year terms today and will be joined next month by incoming Governor Ueda, who will chair the next meeting April 27-28. WIRP suggests around 5% odds of liftoff April 28, rising to around 25% June 16 and 40% for July 28. A hike isn’t fully priced in until December 19.

Reserve Bank of Australia Deputy Governor Kent said the nation’s banking system remains strong. Specifically, he said “Volatility in Australian financial markets has picked up but markets are still functioning and, most importantly, Australian banks are unquestionably strong.” He added that “Even if markets remain strained for a time, Australian banks’ issuance will continue to benefit from the strength of their balance sheets.” However, market pricing would seem to disagree. Despite the strong labor market data last week, WIRP suggests nearly 40% odds of a 25 bp cut at the next meeting April 4. Yes, a cut. We simply cannot fathom a rate cut when unemployment remains so low. A pause? Maybe. A cut? Highly unlikely. Of note, the RBA releases its minutes tomorrow for the March 7 meeting. The bank hiked rates 25 bp to 3.60% but signaled a potential pause. Governor Lowe later noted that the RBA will be guided by incoming data on employment, inflation, retail sales, as well as various business surveys in deciding on whether to hike rates or pause at the April 4 meeting. He noted that “If collectively they suggest the right thing is to pause then we’ll do that, but if they suggest that we need to keep going we’ll do that. So we’ve got a completely open mind about what happens at the next board meeting.” There was no discussion of a rate cut then, to state the obvious.

Taiwan reported weak February export orders. Orders came in at -18.3% y/y vs. -17.5% expected and -19.3% in January. So far, China reopening has had very little impact on regional trade and activity. Korea reports trade data for the first twenty days of March tomorrow.

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