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VolatilityTrading

A traders' week ahead playbook - the Fed bring out the big guns

13 Mar 2023
We start the week on a positive note but with such event risk in front of us volatility remains something that traders need to adjust too and respect.

After spending most of the weekend debating who was to blame for SVB Financials demise and who was next in the firing line, we’ve seen the Fed uniting with the US Treasury and the FDIC to bring out the big guns - all strategically timed for the futures open – we’ve seen that Signature Bank has also failed, but in both cases depositors are fully covered and will have access to all deposited capital – this removes a major source of contagion risk and depositors across regional and smaller banks know categorically that the Fed won’t make you wear a haircut and have your back.

We’ve seen a suite of other facilities announced aimed at addressing liquidity and funding concerns – notably, banks can access term funding using collateral valued at par – this is a big deal for banks and a clear positive given collateral used for funding was valued at a discount in the current rate cycle – so funding assets, especially for the more destressed financial institutions is now cheaper.

The Fed are not only addressing concerns over the bank’s asset side of the balance sheet but on the liability side, where they are essentially stepping in front of a larger bank run, which as we’ve seen once again can be devastatingly swift to bring down any institution. The Treasury has been keen to highlight that SVB Financial, which primarily failed to hedge its interest rate exposure, is not being bailed out and it’s the depositors that are their sole focus - the Fed are essentially the lender of last resort.

Still, there's likely going to be further migrations to the stronger banks and those with a large asset base and low equity will continue to see depositors divest capital.

The reaction in markets has so far been positive with the USD following a further rally in the US 2yr Treasury, with yields -11bp on the day. The market now prices ‘just’ 27bp at the 22 March FOMC meeting – we see 61bp of hikes now priced through mid-2023, down from over 100bp last week. Certainly, the data over the past five days is a tailwind to lower interest rate expectations. Clearly, the deterioration in the asset quality held on bank’s balance sheet - much of which is not marked-to-market to show the impact of unrealised losses - is a major consideration.

USD index – daily chart

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The USD is lower vs all major currencies, notably vs the MXN and AUD, where the additional headwind of US equity futures gaining 1.3% is weighing as relief comes into the market. We should see low volatility priced in the VIX index.

One questions how long this goodwill lasts and while the troika of US institutions provides a backstop, it's still concerning that we’re in this position - what other black swans could come as a result of the rapid shift in interest rates?

The price action in the KRE ETF (S&P Regional Bank ETF) could offer broader market direction, while we watch the extent of relief seen in single stock names such as First Republic and Charles Schwab (Pepperstone clients can trade these on MT5) – but also in USD funding and other risk metrics, such as the difference between secured and non-secured funding.

Looking ahead and sentiment in markets and the subsequent price action will most likely be affected by the US CPI print. This is key now and the marquee known event risk that could really move markets around. Naturally given the recent repricing lower in rates expectations it suggests a core CPI print below 0.3% MoM could get the risk party really started.

Conversely, above 0.5% MoM could see the market really open the door to a 50bp hike again – the higher the outcome obviously the bigger the rally in the USD and drawdown in equity markets. The market is seeing a higher probability of an above consensus CPI print, but I think we get a more pronounced move in markets on a lower print than the move we could see on a higher outcome – especially if core services ex-housing was to come in weaker. I guess we’ll never know though.

We will also see US retail sales and PPI, and both could impact given the hotter prints we saw last month. Aussie and UK jobs and the ECB meeting will also get close attention from traders.

It's another huge week in the markets – we could be staring at a big rally in risky assets if inflation comes in soft and we see a sustained rally in financials – where the markets increase conviction that the Fed are close to a pause. Conversely, one can make a compelling counterargument to that, based on an alternate set of outcomes. The fact remains traders need to consider their leverage, and position size and be agile to change – we react, we cut losers without emotion and move on, and we respect but harness the volatility.

The week ahead calendar

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