Financial Stress Continues to Recede

Overview: Financial stress continues to recede. The Topix bank index is up for the second consecutive session and the Stoxx 600 bank index is recovering for the third session. The AT1 ETF is trying to snap a four-day decline. The KBW US bank index rose for the third consecutive session yesterday. More broadly equity markets are rallying. The advance in the Asia Pacific was led by tech companies following Alibaba's re-organization announcement. The Hang Seng rose by over 2% and the index of mainland shares rose by 2.2%. Europe's Stoxx 600 is up nearly 1% and US index futures are up almost the same. Benchmark 10-year yields are mostly 1-3 bp softer in Europe and the US.

The dollar is mixed. The Swiss franc is leading the advancers (~+0.3%) while euro, sterling and the Canadian dollar are posting small gains. The Japanese yen is the weakest of the majors (~-0.6%). The antipodeans and Scandis are also softer. A larger than expected decline in Australia's monthly CPI underscores the likelihood that central bank joins the Bank of Canada in pausing monetary policy when it meets next week. Most emerging market currencies are also firmer today, and the JP Morgan Emerging Market Currency Index is higher for the third consecutive session. Gold is softer within yesterday's $1949-$1975 range. The unexpectedly large drop in US oil inventories (~6 mln barrels according to report of API's estimate, which if confirmed by the EIA later today would be the largest drawdown in four months) is helping May WTI extend its gains above $74 a barrel. Recall that it had fallen below $65 at the start of last week.

Asia Pacific

The US dollar is knocking on the upper end of its band against the Hong Kong dollar, raising the prospect of intervention by the Hong Kong Monetary Authority. It appears to be driven by the wide rate differential between Hong Kong and dollar rates (~3.20% vs. ~4.85%). Although the HKMA tracks the Fed's rate increases, the key is not official rates but bank rates, and the large banks have not fully passed the increase. Reports suggest some of the global banks operating locally have raised rates a fraction of what HKMA has delivered. The root of the problem is not a weakness but a strength. Hong Kong has seen an inflow of portfolio and speculative capital seeking opportunities to benefit from the mainland's re-opening.  Of course, from time-to-time some speculators short the Hong Kong dollar on ideas that the peg will break. It is an inexpensive wager. In fact, it is the carry trade. One is paid well to be long the US dollar. Pressure will remain until this consideration changes. Eventually, the one-country two-currencies will eventually end, but it does not mean it will today or tomorrow. As recently as last month, the HKMA demonstrated its commitment to the peg by intervening. Pressure on the peg has been experienced since last May and in this bout, the HKMA has spent around HKD280 defending it (~$35 bln).

The US and Japan struck a deal on critical minerals, but the key issue is whether it will be sufficient to satisfy the American congress that the executive agreement is sufficient to benefit from the tax- credits embodied in the Inflation Reduction Act. The Biden administration is negotiating a similar agreement with the EU. The problem is that some lawmakers, including Senator Manchin, have pushed back that it violates the legislature's intent on the restrictions of the tax credit. Manchin previously threatened legislation that would force the issue. The US Trade Representative Office can strike a deal for a specific sector without approval of Congress, but that specific sector deal (critical minerals) cannot then meet the threshold of a free-trade agreement to secure the tax incentives. 

The Japanese yen is the weakest of the major currencies today, dragged lower by the nearly 20 bp rise in US 10-year yields this week and the end of the fiscal year related flows. Some dollar buying may have been related to the expirations of a $615 mln option today at JPY131.75. The greenback tested the JPY130.40 support we identified yesterday and rebounded to briefly trade above JPY132.00 today, a five-day high.  However, the session high may be in place and support now is seen in the JPY131.30-50 band. Softer than expected Australian monthly CPI (6.8% vs. 7.4% in January and 7.2% median forecast in Bloomberg's survey) reinforced ideas that the central bank will pause its rate hike cycle next week. The Australian dollar settled near session highs above $0.6700 in North America yesterday and made a margin new high before being sold. It reached a low slightly ahead of $0.6660 in early European turnover. The immediate selling pressure looks exhausted and a bounce toward $0.6680-90 looks likely. On the downside, note that there are options for A$680 mln that expire today at $0.6650. In line with the developments in the Asia Pacific session today, the US dollar is firmer against the Chinese yuan. However, it held below the high seen on Monday (~CNY6.8935). The dollar's reference rate was set at CNY6.8771, a bit lower than the median projection in Bloomberg's forecast (~CNY6.8788). The sharp decline in the overnight repo to its lowest since early January reflect the liquidity provisions by the central bank into the quarter-end.

Europe

Reports suggest regulators are finding that one roughly 5 mln euro trade on Deutsche Bank's credit-default swaps last Friday, was the likely trigger of the debacle. The bank's market cap fell by1.6 bln euros and billions more off the bank share indices. Then there is the US Treasury market, where the measure of volatility (MOVE) has softened slightly from last week when it rose to the highest level since the Great Financial Crisis. While the wide intraday ranges of the US two-year note have been noted, less appreciated are the large swings in the German two-year yield. Before today, last session with less than a 10 bp range was March 8. In the dozen sessions since, the yield has an average daily range of around 27 bp. The rapid changes and opaque liquidity in some markets leading to dramatic moves challenges the price discovery process. The speed of movement seems to have accelerated, and reports that Silicon Valley Bank lost $40 bln of deposits in a single day.

Italy's Meloni government will tap into a 21 bln euro reserve in the budget to give a three-month extension of help to low-income families cope with higher energy bills but eliminate it for others. It is projected to cost almost 5 billion euros. The energy subsidies have cost about 90 mln euros. Most Italian families are likely to see higher energy bills, though gas will still have a lower VAT. Meloni also intends to adjust corporate taxes to better target them and cost less. Separately, the government is reportedly considering reducing or eliminating the VAT on basic food staples. Meanwhile, the EU is delaying a 19 bln euro distribution to Italy from the pandemic recovery fund. The aid is conditional on meeting certain goals. The EU is extending its assessment phase to review a progress on a couple projects, licensing of port activities, and district heating. These are tied to the disbursement for the end of last year. The EU acknowledged there has been "significant" progress. Italy has received about a third of the 192 bln euros earmarked for it. Despite the volatile swings in the yields, Italy's two-year premium over Germany is within a few basis points of the Q1 average (~46 bp). The same is true of the 10-year differential, which has averaged about 187 bp this year. 

After slipping lower in most of the Asia Pacific session, the euro caught a bid late that carried into the European session and lifted it to session highs near $1.0855. The session low was set slightly below $1.0820 and there are nearly 1.6 bln euros in option expirations today between two strikes ($1.0780 and $1.0800). Recall that on two separate occasions last week, the euro be repulsed from intraday moves above $1.09. A retest today seems unlikely, but the price actions suggest underlying demand. Sterling has also recovered from the slippage seen early in Asia that saw it test initial support near $1.2300. Yesterday, it took out last week's high by a few hundredths of a cent, did so again today rising to slightly above $1.2350. However, here too, the intraday momentum indicators look stretched, cautioning North American participants from looking for strong follow-through buying.

America

What remains striking is the divergence between the market and the Federal Reserve. On rates they are one way. Fed Chair Powell was unequivocal last week. A pause had been considered, but no one was talking about a rate cut this year. The market is pricing in a 4.72% average effective Fed funds rate in July. On the outlook for the economy this year, they are the other way. The median Fed forecast was for the economy to grow by 0.4% this year. The median forecast in Bloomberg's survey anticipated more than twice the growth and projects 1.0% growth this year. As of the end of last week, the Atlanta Fed sees the US expanding by 3.2% this quarter (it will be updated Friday). The median in Bloomberg's survey is half as much. 

The US goods deficit in February was a little more than expected and some of the imports appeared to have gone into wholesale inventories, which unexpectedly rose (0.2% vs. -0.1% median forecast in Bloomberg's survey). Retail inventories jumped 0.8%, well above the 0.2% expected and biggest increase since last August. Given the strength of February retail sales (0.5% for the measure that excludes autos, gasoline, food services and building materials, after a 2.3% rise in January), the increase in retail inventories was likely desired. FHFA houses prices unexpectedly rose in January (first time in three months, leaving them flat over the period). S&P CoreLogic Case-Shiller's measure continued to slump. It has not risen since last June. The Conference Board's measure of consumer confidence rose due to the expectations component. This contrasts with the University of Michigan's preliminary estimate that showed the first decline in four months. Moreover, when its final reading is announced at the end of the week, the risk seems to be on the downside, according to the Bloomberg survey. Meanwhile, surveys have shown that the service sector has been faring better than the manufacturing sector. However, the decline in the Richmond Fed's business conditions, while its manufacturing survey improved, coupled with the sharp decline in the Dallas Fed's service activity index may be warning of weakness going into Q2.

The US dollar flirted with CAD1.38 at the end of last week is pushing through CAD1.36 today to reach its lowest level since before the banking stress was seen earlier this month. The five-day moving average has crossed below the 20-day moving average for the first time since mid-February. Canada's budget announced late yesterday boosts the deficit via new green initiatives and health spending, while raising taxes, including a new tax on dividend income for banks and insurance companies from Canadian companies. The market appears to be still digesting the implications. Today's range has thus far been too narrow to read much into it. The greenback has traded between roughly CAD1.3590 and CAD1.3615. On the other hand, the Mexican peso has continued to rebound from the risk-off drop that saw the US dollar surge above MXN19.23 (March 20). The dollar is weaker for fifth consecutive session and seventh of the last nine. It finished last week near MXN18.4450 and fell to about MXN18.1230 today, its lowest level since March 9. However, the intraday momentum indicators are stretched, and the greenback looks poised to recover back into the MXN18.20-25 area. Banxico meets tomorrow and is widely expected to hike its overnight target rate by a quarter-of-a-point to 11.25%.

 

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