Risk appetite improves on ongoing support from the authorities to help contain banking system contagion. Global equities and rates higher; US 2-year Treasuries up 19bps, 10-year rate up 10bps

Equities and global rates are higher, encouraged by the moves of authorities to support the banking system. There is now slightly more conviction that the Fed will deliver a 25bps hike in the next 24 hours. The NZD, AUD and JPY have underperformed against the backdrop of higher global rates.

Risk appetite has improved as investors have become more comfortable that conditions in the banking sector have stabilised, supported by the commitment of authorities. Investors are no longer concerned that the wipeout of AT1 bond holders in Credit Suisse represents a source of contagion risk, give clarity that the rules were peculiar to Swiss documentation.

Furthermore, Bloomberg reported that US officials are studying ways they might temporarily expand FDIC coverage to all deposits. Funding such a policy is a key consideration, given the political constraints, but officials are seeing if they could use the Treasury Department’s authority via the existing Exchange Stabilisation Fund which would avoid needing to go cap in hand to Congress.

And overnight, Treasury Secretary Yellen gave a public commitment to support the US banking system saying “…similar actions could be warranted if smaller institutions suffer deposit runs that pose the risk of contagion”, adding that the federal government is “resolutely committed” to mitigating financial stability risks.

US and European equities are stronger, led by Financials.  The Euro Stoxx 600 index closed up 1.3%, with a 4% gain for Banks. The S&P500 is currently up 0.8%, with the KBW Banking Index up over 5%. The most troubled large bank – First Republic Bank – is up over 50% on the day, supported by JP Morgan CEO Dimon’s plan to support the bank, with talk of converting some, or all of the $30b in deposits from the 11 major banks last week, into capital.

While a sense of calm has returned to markets, a cloud of vulnerability continues to overhang. In Bank of America’s latest monthly survey of fund managers, the biggest fear is seen to be a systemic credit event, replacing inflation as the main worry. The poll showed the most likely source of a credit event is US shadow banking, followed by corporate debt and developed-market real estate. On a similar theme, the WSJ has two articles, one outlining the anxiety in the $8 trillion Mortgage-Backed Securities market, where banks are nursing large losses if they were marked-to-market. The second article noted the record commercial mortgages expiring in 2023 ($270b), and where smaller banks hold $2.3 trillion of such debt. Rising defaults could force mark-downs on these total debt holdings, reducing the capital adequacy of the smaller banks.

For now, higher risk appetite has helped pricing for the FOMC meeting in 24 hours nudge up further to +21bps. And with some paring of future easing, the 2-year Treasury yield is up 18bps on the day to 4.16%, while the 10-year rate is up 10bps to 3.59%, both rates near their highs for the session. European rates are up even more, with Germany’s 2-year rate up 26bps and 10-year rate up 17bps.

In currency markets the worst performers have been the NZD, AUD and JPY, reversing course after being the greatest beneficiaries when US rates were heading lower. USD/JPY is up nearly 1% on the day to 132.60. The NZD has fallen steadily, down over 1% to be back below the 0.62 mark, currently 0.6175 – its strong correlation to risk appetite over the past two years reversing through the recent turmoil.

The AUD has also steadily fallen, albeit less than 1% lower to 0.6660. NZD/AUD shows a modest fall to 0.9275. EUR has outperformed, supported by higher European yields, with the currency now fully recovering its plunge when the spotlight first shone on Credit Suisse a week ago. EUR/USD is up to 1.0765 and NZD/EUR has fallen 1½% to a 5-month low below 0.5740.

In economic releases, US existing home sales for February were much stronger than expected, rising 14.5% m/m, breaking a record string of 12 monthly declines. The monthly selling price fell 0.2% y/y, the first annual decline in pricing in 11 years. Canada CPI inflation fell by more than expected to 5.2% y/y, with the average of three core measures falling to 5.4% y/y. The data support the BoC’s recent decision to pause the rate hike cycle.

The latest GDT dairy auction showed pricing down 2.6%, the sixth drop over the past seven auctions. Prices for all the products on offer fell, with whole milk powder down 1.5% and skim milk powder down 3.5%.

The domestic rates market showed strong demand for NZGBs, with yields 9-10bps lower across the curve, the 10-year rate down to 4.11%, catching a tailwind from lower Australian rates. This was a notable outperformance against swaps, with the 2-year rate down 6bps and the 10-year rate down 2bps.

On the calendar ahead, Westpac’s NZ consumer confidence index is likely to remain depressed.  UK CPI data are expected to show a small moderation in annual inflation for the headline and core measures.

But focus will be on the FOMC meeting outcome tomorrow morning at 7am, followed by Powell’s press conference at 7:30am.  We’ll delay publication of our next Markets Today to capture the initial market reaction.  The market and economists believe a 25bps hike is the most likely outcome, although one could understand a pause decision given the banking sector turmoil. Because the outlook has become a lot cloudier, the market will likely put less focus on the projections.  Whatever the forecasts are, they will be highly conditional on how the banking sector turmoil plays out over coming weeks. Powell would be wise to not be too precise with forward guidance.  Policy actions from here will be highly data and market dependent. What the Fed does with its QT programme will be of keen interest.  Some changes look to be in order, given the expansion of the Fed’s balance sheet working at cross purposes with the QT programme.