US Banking Crisis Swamps Other Considerations

Overview:  The US banking crisis has overwhelmed other market drivers. The strong measures announced as Asia Pacific trading got under way was embraced by the market even though moral hazard issues and gaps in the Dodd-Frank regulatory framework were exposed. The dollar is trading heavily. The prospect of a 50 bp Fed hike next week has evaporated and some are doubting that a 25 bp increase will be delivered. Rate hike expectations for the ECB this week and the BOE next week have been shaved, and the market now favors the RBA to join Canada in pausing as early its meeting next month.

Outside of China, Hong Kong, Taiwan and South Korea, equities have traded heavily. The Nikkei was off 1.1% and Europe's Stoxx 600 is more than 2% lower, its biggest loss so far this year. US equity futures have lost the early upside momentum. The most dramatic action is in the debt market, where US 10-year yields are off 14 bp to 3.56%. European benchmark yields are down 13-20 bp, and the 10-year JGB yield is down 10 bp (to slip below 0.30%). US and European two-year yields are off even more (23-35 bp) as the banking crisis is seen impacting the outlook for monetary policy. Lower rates and a weaker dollar saw gold gap higher and approach $1894 before consolidating. May crude has fallen around 1.7% to about $75.40 and give back its pre-weekend gains. 

Asia Pacific

While China's Xi's third term at pinnacle of state and party signaled continuity, there was much speculation of the changing of top financial officials. However, yesterday it was announced that PBOC Governor, and the finance and commerce ministers have been given new terms. Notably, PBOC Governor Yi and Finance Minister Liu had reached the mandatory retirement age and were dropped from the leadership ranks of the Communist Party last year. Maintaining some of the top personnel at the same a new more centralized and powerful financial regulatory signals a type of balance. Separately, Li Qiang succeeded Li Keqiang as premier. As widely expected, other Xi loyalists were promoted to more senior positions. Of note, Li Shangfu, who has previously been sanctioned by the US will become the new defense minister. 

Before the weekend, the Japanese government agreed to join the alternative trade dispute resolution mechanism at the World Trade Organization that had been initiated by the EU to circumvent that US blocking of the appellate process. The "Multi-Party Interim Appeal Arbitration Arrangement as a little more than 50 member, including the EU, China, Brazil, Australia, Canada and Colombia. The first ruling of the parallel mechanism issued at the end of last year in dispute over "French fries between Colombia and the EU (Colombia imposed anti-dumping duties on frozen potato exports from Belgium, Netherlands and Germany). 

For at least a couple of years, Saudi Arabia and Iran were working toward a detente, working through intermediaries (Iraq and Oman). China stepped in relatively late in the process and a deal was struck before the weekend to normalize diplomatic ties. Saudi officials kept US officials apprised along the way, according to press reports. After agreement was announced, the White House said that it supported any efforts to de-escalate the tensions. There is hope that exchange of ambassadors will facilitate a comprehensive peace agreement between the Saudi-led coalition and the Ansarallah resistance in Yemen that could be announced over the next couple of weeks that will be more than the extension of the agreement that ended last October. Yet, it may be too much to expect a rapprochement between Saudi Arabia and Iran. There are still various national interests that divide the two besides the Sunni-Shiite tensions. Meanwhile, Iran's uranium-enrichment is thought to be getting close to weapons-grade and it has been developing longer-range ballistic missiles. Separately, the Saudis have expressed interest in joining the Shanghai Cooperation Organization. Often it seems, many Americans view the world in stark terms of either "with us" or "against us" but the reality is often more nuanced and complicated.

The dollar nicked JPY133.00 in the European morning after briefly trading above JPY135.00 in early Asia Pacific turnover. We had cautioned that a sustained break of JPY134 weakens the technical outlook and suggests potential toward JPY132.00. The drop in US rates also dragged down the JGB yield and eases pressure on the BOJ's yield curve control. After posting a bearish outside down day ahead of the weekend, the Australian dollar rallied to a four-day high near $0.6680 before stalling. The $0.6700 area needs to be overcome to lift the tone, and the inability to remain above the pre-weekend high (~$0.6640) is disappointing. The futures market has practically given up on the idea of an RBA rate hike next month. The greenback returned to the CNY6.8665 area after trading above CNY6.9700 before the weekend. The low set earlier this month was around CNBY6.8625. The dollar recovered to back to a little above CNY6.90, where it has steadied. The PBOC set the dollar's reference rate a little stronger than expected (CNY6.9375 vs. CNY6.9366), which seemed to have signaled a desire to temper the dollar's weakness. 

Europe

The fear of a crisis that spurred a sharp drop in US rates ahead of the weekend pushed European rates sharply lower too. The two-year German note yield tumbled 18 bp (to about 3.10%). That was the biggest single day decline in eight months. The ECB meets this week, and many market participants recall the ECB's hike in 2008 after Bear Stearns ignoble sale and the failure of Lehman. The swaps market shaved the odds of a 50 bp hike this week from nearly a done deal in the middle of last week to a still-confident 80% chance ahead of the weekend and now near 70%. In the risk-off rally, peripheral European debt did not rally as much as the core, which makes intuitive sense, but it illustrates a channel of contagion.

To compete with US and China subsidies to more environmentally friendly technologies, the EU proposes to relax the state aid rules. The changes are temporary and will extend through the end of 2025 and allows governments to match the support offered by other countries for targeting investments in a range of industries, including batteries, solar panels, wind turbines, heat pumps, and the production and recycling of rare earth elements. Governments can provide higher levels of support to individual companies where there is a real risk of investment being drawn away from Europe. There appears to be two key safeguards. First, this "forbearance" is not to foster competition between EU members. Second, the rules attempt to ensure that the poor parts of the EU can also have easier access to funds. Since budget rules were relaxed since Russia's invasion of Ukraine, Germany and France accounted for around 70% of state aid measures, which underscore the fear of destabilizing divergence.

The euro rose slightly above $1.0735, its best level since the middle of last month. However, it has not been able to sustain the break of $1.0700 and pulled back to around $1.0665 in the European morning. The intraday momentum indicators are overextended, and provided the $1.0650 hold, another try at $1.07 seems reasonable. A break of $1.0650, though, could see $1.06. While ECB rate expectations have been reduced by the US financial crisis, in the UK, the immediate impact is on expectations for Wednesday's spring budget. The UK arm of SVB was sold to HSBC. Sterling traded to $1.2140, a new high for March. It reached almost $1.2115 before the weekend. Like the euro, sterling's upside momentum faded, and it approached initial support near $1.2050 in the European morning. The market also is less confident of a BOE rate hike next week. In the swap market, the odds of a quarter point hike have fallen from almost 100% to 60%. The intraday momentum indicators are also overextended and provided the initial support holds can retest the $1.2100 area in North America.

America

The US Treasury, Federal Reserve, and FDIC have attempted to ringfence the potential banking crisis, with Signature Bank closed, as well by NY state officials. The Federal Reserve announced a new facility (Bank Term Funding Program), which allows banks to exchange their government, agency, and MBS debt at par for cash for up to one-year. The Treasury will make available $25 bln from the Exchange Stabilization Fund (similarly used during the Great Financial Crisis) to backstop the new Fed facility, but Fed officials do not expect to need it. The cost of accessing the BTFP is one-year OIS plus 10 bp. By accepting the long-term high-quality assets, like Treasuries, agencies, and MBS at par rather than a market prices, more liquidity is available.

The collateral requirements of the discount window now will be the same as for the new Bank Term Funding Program, which means a smaller haircut and therefore less unattractive option. The FDIC is invoking the "systemic risk exception" and will cover the gap between the sale of SVB assets and the deposits. Officials confirmed what the market already suspected (revealed preferences) that there were several other banks that were vulnerable. The FDIC is funded by a levy on banks not taxpayers. There may be moral hazard issues here as the uninsured depositors are treated as insured, but not shareholders or necessarily creditors. This is the first post-Dodd-Frank financial crisis, and more work is clearly needed. 

The combination of the drop in US rates and the rally in stocks helped lift the Canadian dollar. Before the weekend, the greenback set a new high for the year near CAD1.3860 and today approached CAD1.3710. The Bank of Canada's pause, which had looked like an anomaly before now seems a bit prescient. Still, as the US dollar has returned to previous support around CAD1.3750, which is now serving as resistance. Above there, scope extends back to the CAD1.3785 area. The US dollar has traded on both sides of its pre-weekend range against the Mexican peso (~MXN18.27-MXN18.5950). The close is key for this price action and settlement above the pre-weekend high would suggest corrective forces have not run their course. A move above MXN18.66 could target MXN18.76 initially. However, the intraday momentum indicator is overbought, and this is the kind of peso pullback for which some had been waiting or hoping to offer a new opportunity. 

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