CAPITALDIGEST MARKET REVIEW, 03/4/2023

DOLLAR REBOUNDS AS BANKING FEARS FADE; YEN FALLS ON QUARTER-END FLOWS The dollar rose against most major peers on Wednesday, reversing some of its recent declines, and gained sharply against the yen, which was volatile as the end of the Japanese fiscal year approaches. The dollar index, which measures the currency against six rivals, was 0.18% higher on the day at 102.67, pulling away from the near seven-week low of 101.91 touched late last week. “The recent failures in the financial sector of the U.S. appear to be contained and the immediate bleeding has stopped,” Helen Given, FX trader at Monex USA, said. Improving risk sentiment and investor hopes that central banks can once again turn their attention toward fighting inflation was helping support the dollar, Given said. “Though we see some downside for USD in the second half of the year, dollar strength looks likely to continue on its current path for now,” she said. Global financial markets were roiled in recent weeks as investors balked at the collapse of two U.S. lenders and the rescue of Credit Suisse, with the dollar coming under pressure as worries grew that the market turmoil may leave the Federal Reserve unable to persist with its inflation-fighting interest rate hikes. Worries, however, have faded this week as investors took solace from First Citizens BancShares’ agreement to buy all of failed lender Silicon Valley Bank’s deposits and loans, and the fact that no further cracks have emerged in global banking in recent sessions. On Tuesday, Michael Barr, the Fed’s vice chairman for supervision, told the Senate Banking Committee that Silicon Valley Bank’s problems were due to “terrible” risk management, suggesting it could be an isolated case. “Vice Chair Barr’s testimony to Congress yesterday helped provide USD with a little life raft, easing fears that the Fed may not be able to contain the damage of the last few weeks,” Given said. The dollar rose to a one-week high against the yen, which remained volatile in the run-up to the end of the Japanese fiscal year on Friday. DOLLAR WEAKENS AS INFLATION DATA LIFTS EURO The U.S. dollar fell to a 1-week low against the euro on Thursday as German inflation data helped lift the common currency and as concerns over the banking sector receded. Inflation eased significantly in Germany in March on the back of lower energy prices but was above forecasts, adding pressure on the European Central Bank to further tighten its monetary policy. Separately, data showed that Spain’s consumer prices rose 3.3% year-on-year in March, the slowest pace since the 12-month period through August 2021 and less than expected by analysts. The European Central Bank, which has made it clear future rate hikes will depend on economic data, has increased its key deposit rate by 350 basis points to 3% since July as it seeks to tame surging inflation. “There is a divergence developing between the ECB and the Fed that is going to weigh on the dollar,” Bipan Rai, North America head of FX strategy at CIBC Capital Markets in Toronto, said. “(European inflation data) suggests there is more work for the ECB to do and that could close the policy rate gap between the ECB and the Fed going forward,” he said. Last week, the Federal Reserve’s Federal Open Market Committee raised interest rates by 25 basis points, as expected, but took a cautious stance on the outlook because of the banking sector turmoil. “We believe the main pillars of U.S. dollar strength last year — aggressive tightening by the Federal Reserve and a resilient U.S. economy — are unlikely to support the currency going forward,” Mark Haefele, chief investment officer at UBS Global Wealth Management, said in a note on Thursday. Haefele recommended increasing exposure to select G10 currencies, including the Australian dollar, the Japanese yen and the Swiss franc. On Thursday, the euro was 0.55% higher at 1.09035, the highest since March 23. For the year, the euro was up nearly 2% after having slumped 5.7% in 2022. STERLING EASES AGAINST DOLLAR BUT HEADS FOR MONTHLY GAIN Sterling eased versus the dollar on Friday as a murky economic outlook overshadowed data showing Britain’s economy avoided a recession in the final months of 2022. Despite meagre trading on Friday, the pound remains on track for its biggest monthly gain in four months of 3%, and a 2.4% quarterly gain. “The pound is set to be the best-performing currency of the first quarter of 2023, having gained 2.5% against the dollar”, wrote Francesco Pesole, FX strategist at ING in a note. “Along with the improvement in the economic outlook, sterling is definitely drawing benefits from the market’s conviction that the Bank of England will need to continue raising rates.” Data on Friday showed gross domestic product (GDP) increased by 0.1% between October and December after a preliminary estimate of no growth. Household finances were boosted by state energy bill subsidies but investment by businesses fell. British house prices also slid in March at the fastest annual rate since the financial crisis, mortgage lender Nationwide said on Friday. High inflation and worries about weak growth are still weighing on the pound, which was down 0.10% at $1.23740 by 1124 GMT. The pound meanwhile ticked up slightly against the euro to 87.97 pence. Data last week showed British inflation unexpectedly rose to 10.4% – over five times the Bank of England’s target rate of 2% and the highest among the Group of Seven rich nations. Even so, the pound is set to end the month 3% higher against the dollar, erasing February’s 2.4% drop. The BoE raised interest rates last week for the 11th time in a row. Markets are pricing in a 60% chance of a further 25 bp hike from the central bank in May, and a 40% chance of no change. DOLLAR TO LOG QUARTERLY DROP AS RATE HIKE BETS RECEDE The dollar tracked toward a second consecutive quarterly loss on Friday, as investors see U.S. interest rates close to peaking and expect the dollar’s yield advantage is in decline. A modest boost from a rush to safety around mid-March as banking jitters hit global markets seems to be fading, and the dollar index is down 1.3% for the quarter. Moves in the Asia session on Friday were modest, as a tense calm settled on traders, who still have an eye on the prospect of further deposit flight at U.S. regional banks. The euro rose 0.5% overnight after stronger-than-expected German inflation figures reinforced expectations that there are a few more rate increases left in the Euro zone. The euro was last a fraction firmer in Asia at $1.0908. The dollar drifted 0.2% higher on the yen to 133.07 yen. Through March, U.S. interest rate markets dramatically repriced the outlook and now see a roughly 40% chance that the Federal Reserve is finished with rate increases. Fed funds futures have priced rate cuts by year’s end. “The dollar is likely to be range-bound until the impact is a little clearer but if the re-pricing of the outlook for U.S. rates sticks, it’s got a fair bit further to fall,” Societe Generale analysts said in a note.“The saga must have an impact on both credit demand and supply and unless economic data recover very quickly, the end of the Fed rate-hiking cycle is surely much closer now, and the dollar remains way above long-term average levels in real terms,” they said, in reference to recent banking turmoil. The collapse of Silicon Valley Bank three weeks ago unleashed broader worries about banking confidence around the world – forcing Credit Suisse into the arms of rival UBS and sending bank shares sliding from London to Tokyo. Currency markets were in general steadier than stocks and did not reflect the wild volatility seen in bond trade, though the yen – seen as a safe haven thanks to Japan’s status as the world’s biggest creditor – is up 2.5% for the month, its best March performance since 2008. Central bank meetings loom in Australia and New Zealand next week, and markets havepriced a pause for Australia and step-down in pace to a 25 basis point hike for New Zealand. DOLLAR TRIMS GAINS VS EURO AFTER U.S. INFLATION DATA The dollar pared gains against the euro on Friday after U.S. data showed personal consumption expenditure growth slowed in February, supporting hopes of a softer monetary policy approach from the Federal Reserve. U.S. consumer spending rose moderately in February, likely payback after surging the prior month, and while inflation showed signs of cooling it remained elevated, which could see the Fed raising interest rates one more time this year. Earlier in the session, data showed euro zone inflation dropped by the most on record in March, but core price pressures, which exclude food and energy, accelerated, maintaining pressure on the European Central Bank to keep raising rates. The data has left markets positioned for more rate rises in the euro zone than in the United States “In terms of inflation, I think the Fed is in a better position to the ECB,” said Stuart Cole, head macro economist at Equiti Capital. “Yes, inflationary pressures are above target, but you look at the U.S. and both headline and core are moving in the right direction, albeit painfully slowly. But in the euro zone you have a divergence which makes policy-making much harder,” Cole said. The euro was 0.06% lower at $1.08975 after the data. The common currency had slipped as much as 0.37% to a low of $1.08645 earlier in the session. The Fed is seen as about as likely to raise its benchmark overnight interest rate in May as not. But even if it does, it is expected to reverse course quickly and end the year with rates lower than they began, according to futures contracts tied to the U.S. central bank’s policy rate. “My gut feeling is that the Fed will go for another 25 basis points in May, and that will be it … but the ECB I can see hiking aggressively still into the summer,” Equiti Capital’s Cole said. “You can potentially see that being positive for EUR/USD from the interest rate perspective,” he said.