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Trader thoughts - the markets are sending a message and it isn’t positive

Chris Weston
Head of Research
Mar 13, 2023
The world literally changed in the past 12 hours and the message we’re hearing is not a positive one

Despite the suite of defiant actions from the FDIC, the Fed, and the US Treasury, the markets are seeing further pain and side effects from higher interest rates, and the potential for further bank failures.

On one hand, one could argue the actions from the US authorities are not seen stopping the contagion effect and that more failings will be coming – depositors demand strength and security, so the big banks could benefit from this. At least we have a roadmap on how uninsured deposits will fare if a bank does fail.

At the root of the issue is the market sensing new regulations have to come and this will impact margins and have an impact on economic activity – the ability of SVB Financial and other banks to use FDIC-insured deposits, subsequently purchasing ‘high quality’ securities and house a massive chunk of these positions in its ‘Held To Maturity’ (HTM) book - where they don’t mark-to-market the value of the bonds daily, and can’t hedge the interest rate risk, seems something that will be addressed.

The market is pricing new regulations and that could have implications for credit and ultimately tighter financial conditions – in effect, this could do the work of interest rate hikes - growth will find it hard going here, and this has led to a radical repricing in the rates and bond market – last week we were pricing a strong chance of a 50bp hike from the Fed - now one investment bank is calling for a 25bp rate cut and a pause on QT at next week’s FOMC meeting, while several others, such as Goldman Sachs, are calling for a pause.

The market is now pricing just 13bp of hikes, so a rate hike next week is essentially a coin toss, while we see only 19bp of hikes cumulative before cuts start to be priced for June. This repricing was swift, it was brutal, and it changes the investment landscape.

Ahead of this week’s ECB meeting the market now prices 38bp of hikes here, despite the ECB only recently telling us that 50bp was a done deal. We see peak ECB rates pricing now at 3.29%, down from well above 4% last week. In Australia, swaps pricing essentially says the RBA is done with its hiking cycle.

In both cases, we’ve seen funds pile into German and US 2-year bonds, with the latter -61bp to 3.97% and undergoing its biggest 3-day move ever.

Banks have been savaged and we’ll be watching to see how Asian banks fare today, that could be very telling especially into the close. In the US the KRE ETF (S&P Regional bank ETF) closed -12.3%, with many of the regional names getting taken to the woodshed. The cost of insuring against bond default (CDS) has blown up, as is the case for EU banks. Even the marquee banks have found sellers and they may even benefit from this longer-term.

The USD has found sellers again, with the DXY -0.9% and following the US 2yr Treasury lower. We also saw German 2yr bond yields smashed, but not to the same extent and the USD has followed rate differentials lower. We see the US Dollar index on the 103.21 December 2022 support lows, although EURUSD has now printed a higher high and broken out. High beta FX has worked well, as has gold and crypto.

There is clearly more to play out here but the question on the floor this morning is, have the moves in rates and by extension, the USD gone far too far?

One questions how much of this move in rates and bonds has been driven by a liquidation of bond shorts and other types of hedging flows. Clearly, the news flow warrants a reduction in interest rate expectations but are we at that point already when the Fed pause? I think it is overdone myself, but I’d be hesitant to get in front of the move just yet, but there are big opportunities coming.Today’s US CPI print (out at 23:30 AEDT) could be helpful in justifying this pricing – the market craves a weaker number, where a core CPI of 0.3% MoM or lower could be a welcome relief to the broad equity market. A number above 0.5% becomes problematic and it's hard to paint a positive picture of equities and risk in that environme

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