With risk aversion diminishing, the S&P 500 rallied 1.8% in yesterday’s session, supporting a 0.3% rise in CAD against the US dollar. Oil prices—the other main driver of weakness two days ago—remained in the doldrums, however, edging slightly higher to $68 amid ample volatility. Despite trending in the right direction amid a better supported risk backdrop, USDCAD is not back in its pre-SVB range. The main Canadian economic news of the day was the release of the latest wholesale sales report, which missed expectations for a 3% gain in January. At 2.4%, however, this still marked a solid improvement in business activity from the month prior, but we’ve known for a while that all the January data got skewed upward by seasonal effects. Today’s key data points will be industrial product and raw materials price indexes for February. Surveys expect the former to cool to 0.2% and the latter to maintain the pace of decline at -0.1%, which, if realised, would add further support to our view that inflation should mean-revert in next Tuesday’s report.
The broad dollar index slumped in yesterday’s session as markets witnessed two separate acts either side of the Atlantic aimed at installing confidence in the banking system. In Europe, the ECB showed confidence in its macroprudential measures as it followed through on its forward guidance by hiking rates 50bps, while in the US, a conglomerate of major banks agreed to inject $30bn of uninsured deposits in First Republic in order to shore up confidence in the 14th largest commercial lender’s stock. Overall, both sets of measures helped to stabilise the recent outflow in banking stocks, even if it does only prove to be temporary. This saw the dollar retrace part of its recent haven rally, which has extended overnight. The DXY index now sits just 0.16% above its opening level on Wednesday, meaning it has almost retraced the entirety of its Credit Suisse haven bid. While the risk backdrop continues to be somewhat supported overnight, we would still remain cautious at this juncture. Although cynical, we believe that it is concerning that the US banking system is starting to group together to protect itself. In this light, we continue to favour refuge in USDJPY, especially after Japan’s Trade Union Confederation signalled that average monthly wage agreements across 805 unions was 3.8% this year–a sign that should prompt renewed expectations of BoJ tightening in Q2. For FX markets today, with the data calendar sparse, the tone will again be set by the performance of global equities.
While the market’s confidence in a 50bp hike from the ECB yesterday was dashed by the recent turmoil in banking stocks and the concerns that arose about overall financial stability, our expectation of this outcome remained stable. In our view, anything but a 50bp hike from the ECB at a time when core inflation pressures are rising would only spark further confidence issues in markets. Although not evident until after the press conference when ECB members starting speaking to media under the guise of unanimity, this view was ultimately the prevailing one amongst the Governing Council. Within the press conference, President Lagarde hinted at this as well, stating that there wasn’t a discussion over the size of the hike, but whether now was the time to embark upon it. The outcome of this debate saw the council near-unanimously vote in favour of the latest decision to raise the deposit rate to 3%, with just 3-4 members favouring a temporary hold. Despite the increased level of speculation heading into yesterday’s meeting, the response in markets to the decision was relatively muted. The Stoxx 600 bank index was little changed on the day, the euro rallied by 0.3%, and the market implied terminal rate rose moderately to 3.2%. Given how markets were trading in the days leading up to the ECB decision, this can be considered a positive outcome. This morning, ECB speakers have hit the wires to entrench the latest decision, stressing the strength of the eurozone banking system and the macroprudential measures that are in place to prevent any further fallout from Credit Suisse. This is best evidenced by comments from Bank of France Governor Francois Villeroy de Galhau, who said “we have sent a signal of confidence that is strong and double: it’s confidence in our anti-inflation strategy and confidence in the solidity of European and French banks.” Following news that US G-SIBs such as Bank of America and JP Morgan will park a cumulative $30bn of uninsured deposits at US regional bank First Republic to stabilise its stock, and supportive commentary by ECB members, the euro finds itself 0.5% higher against the dollar this morning as global equity futures trade in the green.
With no significant UK data releases due today and markets beginning to calm following the intervention of Swiss regulators to support Credit Suisse, any price action in sterling will likely continue to be driven by developments elsewhere. Meanwhile, thoughts will begin to turn towards the events coming up next week. In the UK that includes the release of CPI data on Wednesday, followed by a Bank of England Rate decision on Thursday and rounded off with Friday’s release of PMI data. All this will all take place against a backdrop of the Spring Budget revealed on Wednesday this week which in addition to new policy announcements suggested the UK economy is now likely to avoid recession in 2023. Based on OBR projections for UK economic growth the budget also included a forecast for UK CPI to fall to 2.9% by year end, implying the UK economy is in a far better shape than it was expected to be even a few months ago. Of course this does not mean that the Bank of England will agree when it comes to Thursday’s rate decision. Indeed, the UK has a bizarre situation where monetary and fiscal policy are predicated on two different sets of forecasts which at this point in time point towards starkly different paths for the UK economy over the coming years. Despite the release of the more positive OBR forecasts, it seems likely that the Bank of England will stick with its bearish outlook for the time being, at least until the release of the next Monetary Policy Report, which will accompany the May meeting. Therefore, despite market expectations for inflation to tick down on Wednesday, our view is that the Bank of England will not have seen sufficient weakening in the inflationary outlook to pause its rate hiking cycle, suggesting that a 25bp rise in rates is the most likely outcome for the meeting. This will leave the Bank Rate at 4.25%, which we see as being the terminal level with data releases between now and May likely to show an easing of labour market pressures, accompanied by more sustained reductions in both headline and core inflation. The first signs of this improvement may well be seen on Friday with the release of PMI data. Given it was the February PMI report that was the first significant data release to really move the narrative in a direction of a better UK economic outlook by showing a surprise expansion in activity, hopes will be that this upcoming release will continue that trend, pointing towards more robust activity and weakening inflationary pressures.