Dollar Soft as Risk Off Impulses Fade

March 17, 2023
  • The biggest banks in the U.S. agreed to deposit $30 bln with First Republic Bank in an effort to reassure depositors; banks borrowed a combined $164.8 bln from two Fed backstop facilities in the most recent week; Fed tightening expectations remain depressed; the labor market remains strong; the manufacturing sector continues to weaken; Michigan preliminary March consumer sentiment will be closely watched
  • ECB hiked rates 50 bp, as we expected; President Lagarde maintained s delicate balance in her press conference; Lagarde stressed that there is no trade-off between price and financial stability; the détente didn’t last long as ECB hawks went on the warpath; Russia kept rates steady at 7.5%, as expected
  • Japan-Korea traded tensions are easing; PBOC cut reserve requirements for commercial banks by 25 bp; Thai Prime Minister Prayuth dissolved parliament to set up general elections in May

The dollar is soft as risk off impulses fade. DXY is down for the second straight day and trading near 104.21 after trading as high as 105.103 this week. We believe that the dollar smile is back in play; while the safe haven boost has faded, the dollar should benefit from the repricing of Fed tightening expectations as the banking crisis ebbs. The euro is trading higher near $1.0635 in the wake of the ECB decision (see below), while sterling is trading higher near $1.2135. USD/JPY is trading lower near 133 despite ebbing risk off impulses. With the BOJ seen on hold for the foreseeable future and banking sector tensions 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.


The biggest banks in the U.S. agreed to deposit $30 bln with First Republic Bank in an effort to reassure depositors. JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo will contribute $5 bln of uninsured deposits each, while Goldman Sachs and Morgan Stanley will contribute $2.5 bln each. Other banks will deposit smaller amounts to make up the final $5 bln. The joint statement from the banks said that “This action by America’s largest banks reflects their confidence in First Republic and in banks of all sizes.” Reports suggest the rescue effort was led by JPMorgan Chase CEO Dimon and Treasury Secretary Yellen. A joint statement from the Fed, Treasury, and FDIC said “This show of support by a group of large banks is most welcome, and demonstrates the resilience of the banking system.” The Fed added that it “stands ready to provide liquidity through the discount window to all eligible institutions.”

Banks borrowed a combined $164.8 bln from two Fed backstop facilities in the most recent week. Data published by the Fed showed $152.85 bln of borrowing from the discount window for the week ended March 15, a record high and up from $4.58 bln the previous week. The prior high was $111 bln seen during the 2008 financial crisis. Data also showed that banks borrowed $11.9 bln from the Fed’s new Bank Term Funding Program. While the increased borrowing is obviously a sign of the growing stresses in the banking sector, that is what these backstops are there for. As the crisis ebbs, we expect banks to pay back these loans.

Fed tightening expectations remain depressed. WIRP suggests a 25 bp hike March 22 is nearly 85% priced in. Yesterday's ECB hike in the midst of banking sector tensions (see below) cements our view that the Fed hikes 25 bp next week and then maintains the meeting by meeting approach. One last 25 bp hike May 3 is only around 55% priced in, we believe those odds will rise as the banking sector crisis ebbs. Furthermore, one or two 25 bp cuts are priced in by year-end and that is simply not going to happen. Because the media embargo went into effect midnight Friday, there will be no Fed speakers until Chair Powell’s post-decision press conference March 22.

The labor market remains strong. Weekly initial claims fell to 192k vs. 205k expected and a revised 212 (was 211k) last week. The 4-week moving average for initial claims fell to 196.5k. Next week's initial claims data will be for the BLS survey week containing the 12th of the month. If we get another low reading, think we will get another solid NFP for March. Of note, continuing claims are reported with a one-week lag and fell to 1.684 mln vs. 1.723 mln expected and a revised 1.713 mln (was 1.718 mln) last week.

The manufacturing sector continues to weaken. February IP will then be reported Friday and is expected at 0.2% m/m vs. flat in January. Manufacturing is expected at -0.3% m/m vs. 1.0% in January. Yesterday, Philly Fed came in at -23.2 vs. -15.0 expected and -24.3 in February and came a day after the Empire survey kicked things off and came in at -24.6 vs. -7.9 expected and -5.8 in February.

University of Michigan preliminary March consumer sentiment will be closely watched. Headline is expected to remain steady at 67.0, with a small drop in current conditions offset by a small rise in expectations. Of note, 1-year inflation expectations are seen steady at 4.1% while 5- to 10-year expectations are seen steady at 2.9%. February leading index will also be reported and is expected at -0.3% m/m vs. -0.3% in January.


The European Central Bank hiked rates 50 bp, as we expected. The bank acknowledged recent market tensions, noting that that imply added uncertainty to its baseline assessments. It said its toolkit is equipped to provide liquidity support if needed, while TPI is available to address unwarranted, disorderly market moves. The bank state that the eurozone banking sector is resilient. These statements were all meant to calm the markets and we think that's the right stance to take. However, the ECB refrained from signaling future rate moves in its statement. This was the compromise that we were looking for from the hawks in return for a 50 bp hike.

President Lagarde maintained that balance in her press conference. She said risks to growth remain tilted to the downside but highlighted upside risks to inflation. She noted that underlying price pressures remains strong and that wage pressure have strengthened. Most importantly, Lagarde reiterated a data-dependent approach going forward and highlighted the ECB’s reaction function of maintaining price and financial stability. That said, she noted that if the ECB’s baseline scenario remains intact after this period of heightened uncertainty, “more is needed.” She said no other option besides 50 bp was proposed and that it was agreed to by “a very large majority,” adding that 3-4 members wanted more time to monitor the situation.

Madame Lagarde 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 next week. Updated macro forecasts were released. As we expected, the ECB cut its headline inflation forecasts across the board. However, it raised its core inflation forecast for 2023 but cut them for 2024 and 2024. To us, this signals further hikes ahead but not as aggressively as was priced in before. WIRP now has a 25 bp hike priced in for May 4 with virtually no odds of a larger 50 bp move. After that, one last 25 bp hike is priced in for Q3 that would see the deposit rate peak near 3.5%.

The détente didn’t last long as ECB hawks went on the warpath. Kazimir said “The future development of inflation over the entire horizon of our forecast period speaks clearly in favor of the need to continue. Whether, how vigorously, in how many steps and to where — time and data will show.” Elsewhere, Simkus said “Inflation trends haven’t disappeared. While we must remain cautious regarding future assessment, I still believe this wasn’t the last interest rate increase.” Muller said “The financial markets expect interest rates to continue to rise. To reduce inflation to the numbers that are in this forecast, there’s a presumption that interest rates still need to rise.” As we expected, the divide between the ECB hawks and doves remains as wide as over.

Russia central bank kept rates steady at 7.5%, as expected. However, the forward guidance was hawkish as it noted “If pro-inflation risks intensify, the Bank of Russia will consider the necessity of an increase in the key rate at its upcoming meetings.” The bank highlighted ongoing labor shortages, something that Governor Nabiullina noted at the December meeting when she warned that “Due to a growing shortage of personnel, companies’ labor costs are increasing. This is evident among firm operating in industry, transport, logistics and construction. If wages grow at a rate higher than labor productivity, this may lead to an additional increase in prices through business costs.” Since then, inflation eased to 10.99% y/y in February, the lowest since February 2022 but still well above the 4% target. Next policy meetings are April 28, June 9, and July 21 and it will all be data-dependent.


Japan-Korea traded tensions are easing. Japan said it would ease licensing requirements on key ingredients needed to manufacture semiconductors and displays, fluorinated polyimide, hydrogen fluoride, and photoresists. These three materials are controlled almost totally by Japanese companies as a result of when Japan led the world in semiconductor technology back in the 1980s. The announcement came as relations thawed and the first formal summit between the two nations in more than a decade was held. Japan announced the licensing requirement on exports of these materials to Korea back in 20219 when relations soured from a dispute over the compensation for Korean forced labor during Japan’s occupation of Korea from 1910-1945. Korea had filed a WTO complaint but has now withdrawn it. This is welcome news should ensure that semiconductor supply chains aren’t impeded.

People’s Bank of China cut reserve requirements for commercial banks by 25 bp. It will take effect March 27 and is the first cut since December. The move was likely done to boost growth rather than to address any sort of banking sector problems. We expect the PBOC to continue easing this year, with a rate cut now very likely as it would complement the reserve ratio cut. It is one of the only central banks in easing mode and this divergence should continue to weigh on the yuan. Spreads have moved in favor of the yuan in recent days but this should reverse if yields rise at the short end of the UST as the banking sector crisis subsides.

Thai Prime Minister Prayuth Chan-Ocha dissolved parliament to set up general elections in May. The vote must be held within 60 days of the dissolution of parliament and the Election Commission has initially set May 7 as the date. A final date will be confirmed later. Prayuth remains highly unpopular as he seeks an unprecedented third term as Prime Minister after the coup brought him to power back in 2014. He was forced to start a new party in order to get around constitutional term limits. Prayuth will not only will he face off against the candidate from his former Palang Pracharath Party, but he will also have to contend with opposition Pheu Thai Party’s Paetongtham Shinawatra. She is the daughter of former Prime Minister Thaksin Shinawatra, who was toppled in the 2006 coup and remains very popular. Recent polls suggest that the opposition parties hold an edge over the ruling coalition. THB has been one of the top performers YTD in EM but rising political uncertainty may herald a period of underperformance.

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