Stock and Forex Markets Brace for Turbulent Times Amidst Geopolitical Tensions

Another Eventful Week For Financial Markets

Events are moving at a frantic pace over the US banking crisis, with a dramatic dovish repricing of the Fed curve, US regional banks crashing and European financial heavyweights also getting dragged into the mire. The second biggest bank failure in US history leaves markets on edge and central bankers between a rock and a hard place.

Timing is everything in markets and the current fallout has come on the back of Fed Chair Powell’s recent hawkish pivot at his semi-annual testimony. He had guided that any upcoming rate hikes might be bigger than previously thought and stay high for longer. The world’s most powerful central banker also said the FOMC decision would be heavily data dependent and we get a key piece of that puzzle tomorrow with the latest CPI data.

Core inflation is likely to remain hot, matching the January print, with shelter prices expected to be a key source of price pressures. The spotlight will be on the services sector as the Fed chair has previously acknowledged progress in taming goods inflation but little sign of disinflation in core services ex-housing.

Contagion Fears Slash Rate Bets

Bets on a 50bp rate hike at next week’s FOMC meeting rose above 80% after Powell’s speech last week. But contagion fears have seen money markets now price in a material chance of policymakers keeping rates unchanged at their rate decision gathering in ten days’ time. The moves in Treasury markets have been quite remarkable with the two-year yield, which has historically been a predictor of the Fed terminal rate, moving from a recent high above 5% last Wednesday to around 4% today. The two-day range is second only to Black Monday in 1987.

Bank Tensions Fuel Uncertainty

In the near-term, bank tensions are rife which means uncomfortably high inflation figures will muddy the monetary policy and rate outlook. It is a difficult position for Fed policymakers who are trying to fight a battle with historically high inflation by raising rates, while also addressing potential systemic liquidity issues. Ongoing extreme volatility may also cause more financial stress which could push the Fed further off its hiking path and away from its inflation target.

Dollar Under Fire Ahead Of ECB

The dollar has inevitably come under fire in what is likely to be a very bumpy week for markets. The first major US financial crisis since the GFC in 2008 has seen investors shun the buck in the favour of safe haven currencies like the CHF and JPY. This is what happens in periods of high-risk aversion. Collapsing US Treasury yields mean the difference between rates in the eurozone have also narrowed substantially, pushing EUR/USD up to one-month highs. Thursday’s ECB meeting will no doubt be challenging with President Lagarde facing the same high core inflation issues.

Written on 14/03/2023 by Lukman Otunuga, Senior Research Analyst at FXTM

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