Markets Are Still Tense
We mentioned a "nervous calm" returning to the financial markets earlier today. It did not last very long, though, as focus quickly shifted to Europe and the pressure on Credit Suisse's (NYSE:CS) share price following a statement from The Saudi National Bank, one of CS's largest investors, that it was not interested in providing the company with additional cash. At a time when SVB, the former 16th largest bank in the United States, is still being evaluated, significant losses in CS have unnerved European bank stocks generally.
Market stress has increased as a result of significant losses suffered by European banks. The 3m EUR cross-currency basis swap has extended to 38bp from 15bp at the start of European trading, and the 3m USD FRA-OIS spread has widened back out to +57bp (around Monday's peak). It's important to keep in mind that the cross-currency swap represents the additional cost the interbank market is willing to bear in order to obtain USD finance through the EUR swaps market. It served as a crucial stress indicator both during the financial crisis of 2008 and the beginning of the pandemic in March 2020.
Forex Markets Change Mode
FX markets are currently trading off financial stress after trading for many quarters off the macro impacts of the US inflation/Fed tightening story. As the dollar gains from the extreme (market disruption) end of its smile curve, the EUR/USD is falling today. The price of tomorrow's European Central Bank meeting has changed as a result of the strain on European banks. A solid 50bp boost from the ECB has been reduced to a 35bp hike today.
The Japanese yen and, to a lesser extent, the Swiss franc continue to be top foreign exchange performers, while the USD/CHF is higher today due to the strengthening of the dollar as a result of money market stress. It appears investors are still untangling some of their favorite trades in the Mexican peso and the Hungarian forint, as we mentioned last week.
The Norwegian krone, which trades alongside the Swedish krona at the highest volatility in the G10, is currently down close to 2% versus the dollar, which is obviously not good news for commodity currencies either.
It is obvious that it will take some time for the financial situation to stabilize. Investors may want to hear additional support from monetary and regulatory authorities since the Fed's announcement of increased control for mid-sized US banks may not be sufficient. Also, investors will be watching for the adoption of the Fed's new liquidity program; information on this should be available tomorrow evening.
Now is not the time to be searching for carry or yield in FX markets, with the US MOVE index for US Treasury volatility currently surging over March 2020 levels and the VIX (US equity volatility) moving back to 30%. Therefore, until changes in the banking sector are more obvious, a safety-first mindset will rule. That should imply that the JPY continues to outperform the crosses and possibly even the USD.
Yet, the dollar won't fall until the money market circumstances improve and some confidence is returned to the banking industry. The Fed curve will not fall in price. In other words, try not to sell dollars too quickly.