By Stuart Talman, XE currency strategist
A tumultuous week has ended leaving many unanswered questions regarding the state of the global banking sector and the next move from central banks – continue to raise rates or abandon the inflation fight to remediate financial instability and repel a widespread financial crisis.
Despite lifelines being thrown to Credit Suisse and multiple smaller, regional US banks, fear levels remain elevated as evidenced by ongoing bond market volatility.
The US dollar was weaker, Friday, as US bond yields plummeted, signalling more trouble ahead. The yield on the US 2-year bond, which is more sensitive to changes in Fed policy relative to the benchmark 10-year bond, fell close to 80 basis points for the week, its largest decline since 2001.
The 10-year yield fell around 15 basis points for the week.
Banking industry woes, caused by gaping holes in interest rate risk management frameworks, has led to a dramatic re-pricing in rates markets, pulling down terminal rate expectations for the Fed funds rate from around 5.50% to closer to 5.00% and a move back to pricing in 2023 rate cuts.
This, in turn, has halted the US dollar’s rebound which began in earnest in early February as a run of stronger than expected macro-economic data, lead some to believe the Fed would keep hiking to 6%.
This week the Fed faces its toughest decision of this cycle – follow the ECB’s lead (hiked by 50bps last week) and raise the target rate by 25bps to 4.75%-5.00% or pause to gain a better understanding of potential systemic risks that threatens to topple banks across the globe.
Weekly Fed balance sheet data, published Thursday, indicates the level of stress within US banks. In October 2008, the month after Lehman Brothers collapsed, US banks loaned US$110 billion in one week – at that time, a record. The Fed’s emergency loan facility, known as the discount window lent US$152 billion this past week in addition to another US$12 billion under the new Bank Term Funding Program announced last Sunday following SVB’s failure.
Adjusting for inflation the 2008 and 2023 volumes accessed via the discount window (and BTFP) are worryingly similar.
The Fed had embarked on QT – reducing the size of it balance sheet whilst hiking rates to cool the economy to reign in 40+ year high inflation.
In the blink of an eye, it has now shifted back to balance sheet expansion……whilst not technically QE, its QE by another name.
The shift in Fed policy has ended the dollar’s advance.
The New Zealand dollar was the strongest performer amongst its G10 peers for the week, advancing over 2% to close the week near 0.6260. Springboarding off 0.6130 support on Thursday, the price action suggests NZDUSD will once again attempt to break through key resistance, located at 0.6270.
So, why did the Kiwi rally Friday amidst a risk-off tone and US equities falling?
Unlike the Japanese Yen, the dollar did not attract safe-haven flows given the concentration of financial stability concerns predominantly resides in the US…..this could change should fear levels continue to rise if financial contagion spreads across the globe.
In the short term, the New Zealand and Australian dollars may continue to outperform given their distance from European and US banking turmoil.
As we publish this morning’s update, news has just broken that UBS has upped its initial bid for Credit Suisse, seeking to acquire Switzerland’s second largest bank for around US$2 billion. Whilst there is still much work to be done to complete the deal, risk assets likely open stronger this morning on the news.
Aside from the JPY, the Kiwi was stronger against its other major peers, logging a circa 2% weekly gains against the EUR, ~1.5% vs the CAD, close to 1% against the pound and a third-of-a-percent gain against the Aussie.
The antipodean cross looks to be losing upside momentum, NZDAUD struggling to extend higher through 0.9350 against the headwind on last week’s soft local GDP print and strong AUS jobs numbers.
We look for consolidation between 0.9200 and 0.9350 this week.
Looking to the week ahead, the major event is the Fed’s interest rate decision on Thursday morning, including the latest set of summary economic projections, or “dot plots”.
Will Jay Powell and his colleagues opt for 25bps or a hold?
Will the dot plots materially move given last week’s developments?
The answers to these questions will dictate the US dollar’s direction through the back-end of this week.
The Bank of England also meets this week – also a tight call between no move and 25bps. Like the Fed, the BoE has a difficult decision – prioritise inflation or financial stability.
Other market moving events include UK and Canadian CPI, local trade numbers, RBA minutes and S&P Global PMIs for the US, UK, EU and AUS.
Its tough to make a directional call for the week.
There is a plausible scenario whereby the New Zealand dollar continues to outperform regardless of whether risk sentiment leans positive or negative.
An on-hold Fed and lower dot-plots, NZDUSD likely rips through 63 US cents.
Expect heightened volatility…..the turbulence to continue.
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Stuart Talman is Director of Sales at XE. You can contact him here.
1 Comments
Thanks for the write-up, I appreciate your perspective! After following the USD/NZD daily for the past couple of years, the bank failures (and ‘backstop’ from the fed) would seem to make the US less of a safe haven. It’s easy to see the NZD get stronger from here (to the USD). Will be interesting what the Fed will do this week.
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