Typical market correlations broke down last week, after the forced merger of Credit Suisse with UBS had allayed European banking concerns only temporarily.
The dollar fell against every major currency except the Japanese yen, as investors skewed safe havens and rediscovered their appetite for risk. As far as investors are concerned, no news is good news, and market there appears a growing consensus that the recent bank failures were driven by one-off factors, rather than systemic issues. Emerging markets continued to rally, led by Latin American ones. The latter have become the best performers so far in 2023, a pleasant validation of our positive stance on the region.
Market focus is shifting back from banking headlines to economic data. This will be a sparse week as the holidays approach, but attention will doubtless focus on the US employment report on Friday. Elsewhere it should be a relatively quiet week, with limited trading after Thursday. It will be interesting to see the reaction to the massive OPEC cut in oil production announced over the weekend, beyond the huge spike in oil prices of course. So far, the commodity dependent currencies have posted modest advances, although gains appear to be held back by concerns surrounding the impact on higher inflation.
The Canadian dollar has been the best performing currency in the G10 in the past week, buoyed by strong economic news, the stabilisation in financial markets and today’s jump in global oil prices. CAD was one of the underperformers during the recent banking turmoil, as investors bet in favour of an aggressive pace of BoC rate cuts. These bets have, however, receded quite sharply as markets increasingly view the bank failures as isolated incidences, and a first rate cut is now not seen until September.
In our view, the BoC is almost certain to keep rates unchanged at next week’s meeting, although data in the interim could at least shape the tone of the bank’s communications. The January GDP print beat expectations last week (+0.5 MoM), although conditions appear to have worsened since then. Today’s manufacturing PMI is expected to ease from its seven month highs, while Friday’s labour report is set to show a modest net decrease in employment for March.
The US economy produced two pieces of good news last week. The PMIs of business activity rebounded strongly, adding to the sense that the US economy has so far shrugged off the banking concerns and continues to grow amid a very tight labour market. The February PCE inflation report, the Fed’s preferred measure, came in a touch softer than expected, with the headline number easing to 5% – its lowest level since September 2021.
Both of the aforementioned data points contributed to a strong rally in US stocks and the weakening of the US dollar, as safe-haven flows reversed. This week we expect more of the same, as the path of least resistance for the US dollar is downwards for now. A decent nonfarm payrolls report on Friday could seal the deal for a final 25bp rate hike from the Fed at its March meeting. We do, however, think that it would probably take an extraordinarily strong set of data, particularly on wages, to convince markets of more hikes beyond then.
The ECB is getting little relief from the recent Euro Area inflation numbers. Although headline inflation continues to fall, this is largely due to the sharp drop witnessed in energy prices, particularly natural gas, since the August 2022 peak. The far stickier core inflation index actually printed at yet another record high in March, with the monthly number coming in at double economists expectations. This key metric is now up a whopping 3% above ECB rates, practically guaranteeing a continuation of the recent rate hikes.
The fact that banking fears in the Eurozone seem to have disappeared will leave the European Central Bank with plenty of room to catch up to the Federal Reserve in the coming months. Between interest rate hikes and the excellent news coming from the China recovery, we think that the path is clear for further euro appreciation.
A slightly better than expected Q4 GDP number, which was revised upwards to show modest growth, was all that traders needed to send sterling higher against every other G10 currency last week, save the Canadian dollar. The pound has been the best performing major currency since the start of the year. We attribute this to the resilience of UK economic data, the isolation of Britain’s banking sector to external shocks and the hawkish stance adopted by the Bank of England. BoE governor Bailey warned last week that the recent banking turmoil would unlikely derail additional rate hikes, with another 25bp move appearing highly likely at the next meeting in May.
Every week, the prospect of a UK recession grows less likely and the pound, a long-unloved currency that is by some measures the cheapest among the G10, is reaping the benefits. There isn’t much on tap this holiday week, so we expect sterling to trade tightly together with the euro against non-European currencies.
The Japanese yen has flip flopped from being the best performing currency in the G10 during the height of the banking turmoil, to the worst now that concerns have significantly receded. Even against the US dollar, which fell across the board, the yen was down around 1% last week, and has now lost over half of its month-to-date
gains. A stronger-than-expected set of inflation numbers out last week, notably on the core index, were not enough to save the yen, as investors await the Bank of Japan leadership change before jumping to any conclusions over the impact of the data on monetary policy.
This week is largely void of macroeconomic news out of Japan, aside from household spending data later in the week. With that in mind, an ongoing easing in banking concerns could lead to a continued retracement in the yen, as could heightened expectations for central bank rate hikes following today’s jump in oil prices.