US Banks Central to the Direction of the USD
While much of what we saw from the Fed was expected, the reaction from markets showed many were positioned offside. The fact that US 5yr real rates closed -26bp to 1.23% on the day portrays a market that clearly saw the aggregation of information as dovish and that the Fed is probably done hiking.
Traders look for US bank deposit flow data
Powell made it clear that the Fed are far more open-minded and holds a flexible mindset to react to both price and financial stability risks. It's not just inflation and labour market metrics, but credit and lending data and bank deposit flows are now equally important to Fed policy.
It was the tape in the banks that really interested, and when US Treasury Secretary Yellen detailed that a blanket-wide guarantee on all bank deposits was not on the card we saw the market respond with intent – banks took a bath, rate cuts priced between May to December increased to 80bp, the USD was sold off by some 1%+ and gold rallied.
After an initial burst of positive flow, we saw a bearish reversal in US equity, where notably the Russell 2k (US2000) cash closed -2.8%.
Better buying of risk in Asia – can it last?
Calmer heads prevail through Asia today though and we see good buying in the HK50 and US equity index shorts starting to cover. USD weakness is clearly helpful to the moves in Asia markets.
While the market has shown a clear vulnerability to Yellen’s headlines, the belief is that we may see further banks fail, but at least in the near term, all depositors will be made whole. If deposits were to take a haircut should a bank fail from here, it would be seen as a systemic event, and the US Treasury/FDIC/Fed know this.
The FDIC deposit guarantee is set on a case-by-case basis – an implicit guarantee - but for the time being depositors are safe.
Guarantees aside, the prospect of further heavy outflows, as corporate Treasurers look to reposition capital with bigger banks or into money market funds is still the risk – it is a drawn-out process claiming capital from the FDIC after a bank failure, and companies need the capital to pay staff and other business dealings - its why deposit flow data could be a big driver of markets going forward.
Deposit outflows are likely to result in a risk-off vibe, but the important factor, other than increasing the degree of rate cuts that are being priced into US rates, is that we’re seeing capital redeployed out of US markets and into other jurisdictions, like Europe.
The market loves the EUR
Europe – in the eyes of many – is looking relatively more attractive as an investment destination, where notably the banks are seemingly in better shape, certainly from a capital perspective. The ECB are also the most intent on fighting inflation and Lagarde is leading the pole bearer when it comes to the well-traded central bank divergence trade.
Watch the KRE and XLF ETF
So, we watch the KBE and XLF ETF as central to markets. I am sceptical that the Fed cut by 80bp this year, but the market senses a big slowdown in credit this year, and while the market is exploring this thematic it’s hard to turn bullish on the USD with any conviction.
Not only is the USD showing such bearish momentum, but the banks are being sold into strength and the trend here is lower. The USD may find a better bid as we roll into April, but until the banks turn around and start to print higher highs and lows on volume, then traders will be better sellers of the USD.
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