• Markets are starting to see a measure of calm return; Fed tightening expectations remain lower because of the SVB failure; markets are flying blind in terms of how the FOMC views this current situation; the Fed said it is launching an internal probe of its supervision of SVB; February CPI data today may force markets to refocus on the economic fundamentals
  
• The German 2-year yield has been dragged lower; U.K. reported solid labor market data; BOE tightening expectations have fallen
  
• Japan yields have been dragged lower by the global bond rally; RBA tightening expectations have also been impacted by SVB

The dollar is stabilizing as a measure of calm returns to the markets. DXY is trading higher near 103.805 after three straight down days. We believe this bout of dollar weakness is overdone as Fed tightening expectations should eventually recover. The euro is trading lower near $1.0715 as the rally yesterday ran out of steam near $1.0750. Sterling is trading lower near $1.2155 as the rally yesterday encountered stiff resistance near $1.22. USD/JPY traded as low as 132.30 yesterday but has since recovered to trade near 134. For now, the SVB fallout continues to trump the stronger than expected U.S. data but that is unlikely to continue. Today’s CPI data will likely test the current weak dollar trade.

AMERICAS

Markets are starting to see a measure of calm return. Equity markets are stabilizing, while U.S. Treasury yields are moving higher. This has helped the dollar get some traction. If markets continue to calm, we expect these market moves to continue. Indeed, U.S. stock futures are up modestly as of this writing.

Fed tightening expectations remain lower because of the SVB failure. We couldn’t disagree more. While financial stability is the Fed’s unofficial third mandate, we do not believe SVB meets that criterion. WIRP suggests a 25 bp hike March 22 is about 70% priced in, with no odds of a larger 50 bp move from over 70% pre-SVB. Another 25 bp hike May 3 is only about 25% priced in and so the peak policy rate is seen between 4.75-5.0%. Furthermore, a 25 bp cut is fully priced in by year-end and that still seems highly unlikely despite the SVB crisis.

Markets are flying blind in terms of how the FOMC views this current situation. This is because the media embargo went into effect midnight last Friday and so there will be no Fed speakers until Chair Powell’s post-decision press conference March 22. We suspect Fed officials remain concerned but not concerned enough to derail the tightening cycle. We believe the Fed will want to hear from banking regulators about any other potential land mines out there before this month’s FOMC meeting begins.

In that regard, the Fed said it is launching an internal probe of its supervision of Silicon Valley Bank. Vice Chair for Supervision Michael Barr will lead the review and it is scheduled for public release by May 1, according to the Fed. Chair Powell said “The events surrounding Silicon Valley Bank demand a thorough, transparent, and swift review by the Federal Reserve.” The Biden administration is reportedly pushing for a thorough review of the supervision of SVB by California state banking authorities as well as the San Francisco Fed. Specifically, officials in Washington want to determine whether SVB and Signature Bank conducted the required stress tests during the past year as the Fed hiked interest rates aggressively. Obviously, the biggest question for the markets is whether there are any other shoes to drop. If the Fed and other regulators can show they’ve done their due diligence, that would go a long way in further calming the markets.

February CPI data today may force markets to refocus on the economic fundamentals rather than the banking sector. Headline is expected at 6.0% y/y vs. 6.4% in January, while core is expected at 5.5% y/y vs. 5.6% in January. We thought it would be a good time to highlight the Cleveland Fed's inflation Nowcast model. Right now, it is predicting y/y rates for February CPI of 6.21% for headline and 5.54% for core, which are both above current Bloomberg consensus. If the Cleveland Fed is accurate, the upside miss would likely feed into higher U.S. rates and a stronger dollar. PPI will be reported Wednesday. Headline is expected at 5.4% y/y vs. 6.0% in January, while core is expected at 5.2% y/y vs. 5.4% in January. If these readings run hotter than expected, we think the Fed will likely look through SVB and hike rates this month.

EUROPE/MIDDLE EAST/AFRICA

The German 2-year yield has been dragged lower. At 2.82% currently, the yield suggests that ECB policy has been impacted significantly by recent development and we simply do not believe that to be true. Yes, ECB policymakers are keeping an eye on SVB developments but they are still focused on the inflation fight. We expect the ECB to push back against this perceived dovishness.

This comes ahead of the European Central Bank decision Thursday. It is still 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. Some of the hawks have talked about four straight 50 bp hikes, while the doves have stressed a meeting by meeting approach. The result will likely fall somewhere in between as President Lagarde hammers out another compromise. As things stand, WIRP suggests a 50 bp hike this week is less than 60% priced in now, which seems too low to us. A 25 bp hike in Q2 is priced in, while odds of a last 25 bp hike in H2 top out around 80%. This would take the deposit rate to between 3.25-3.5%, which is well below the expected peak near 4.0% from last week.

U.K. reported solid labor market data. The unemployment rate for the three months ending in January was expected to rise a tick to 3.8% but instead remained steady at 3.7% as 65k jobs were added over that period vs. 53k expected. Average weekly earnings for the same period slowed as expected to 5.7% y/y vs. a revised 6.0% (was 5.9%) in December, which takes some pressure off of the BOE to continue hiking aggressively.

Indeed, BOE tightening expectations have fallen. WIRP suggests a 25 bp hike March 23 is about 65% priced in vs. fully priced in last week pre-SVB. The next and final 25 bp hike in Q3 is only about 70% priced in. Similarly, the swaps market is pricing in a peak policy rate near 4.55% vs. 4.75% last week. This is still well below the peak near 6.25% right after the disastrous mini-budget back in September. Of note, reports suggest HSBC will inject GBP2 billion ($2.4 bln) of liquidity into Silicon Valley Bank’s UK unit after purchasing it for GBP1 over the weekend. This too should help allay market fears of the SVB contagion.

ASIA

Japan yields have been dragged lower by the global bond rally. Of note, the 10-year yield is now trading at 0.22%, well below the current 0.5% YCC ceiling as well as the previous 0.25% ceiling. This takes some pressure off of the BOJ to abandon YCC but this global bond rally is unlikely to last. As contagion fears from SVB ease, yields everywhere should normalize somewhat, especially as the global fight against inflation remains ongoing. That said, odds of BOJ liftoff have fallen dramatically and a move in 2023 is no longer fully priced in.

RBA tightening expectations have also been impacted by SVB. A 25 bp cut is actually about 10% priced in for the next meeting April 4 vs. 50-50 odds last week of a 25 bp hike. While the RBA hinted at a pause at its last policy meeting, it in no way implied a cut anytime soon. The expected terminal rate for the RBA is now at the current 3.60% policy rate vs. 4.45% last month and 3.55% in January. For the RBNZ, the expected terminal rate has fallen to 5.25% vs. 5.5% las t month and 5.0% in January. Simply put, it’s hard for us to believe that the SVB has impacted Antipodean monetary policy in any significant manner.