FX Update: Yellen steals the spotlight as Powell ignored.

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Today's Global Market Quick Take: Europe from the Saxo Strategy Team

FX Trading focus: Fed hikes, but clearly shifts to neutral on introduction of new language in the statement and despite maintaining policy forecasts for now. Treasury Secretary Yellen steals the spotlight with comments on not insuring all US bank deposits.

The Fed went ahead with a 25 basis point hike as most expected and this raised few eyebrows. Somewhat more interesting was the introduction of new language in the FOMC statement that clearly spells out new concerns that the recent turmoil will impact credit transmission into the economy and therefore growth/employment. The following insertion into the statement can be read as a shift to neutral:

“The U.S. banking system is sound and resilient. Recent developments are likely to result in tighter credit conditions for households and businesses and to weigh on economic activity, hiring, and inflation. The extent of these effects is uncertain.“

Those statement changes and the inference we can make from them outweigh the lack of any notable shift in the Fed’s policy forecast.  If the Fed begins to see confirming evidence of a sharp slowdown in the April and May data cycles (much higher risk), its tune and forecasts will change rapidly. Also note that the Fed did mark down the 2023 GDP forecast to 0.4% from 0.5% in December and the 2024 GDP forecast to 1.2% from 1.6% in December.

But Yellen comments in a Congressional hearing that was held simultaneously with the Fed Chair Powell presser quickly hogged the spotlight yesterday as she stated “I have not considered or discussed anything having to do with blanket insurance or guarantees of deposits”. That was not the kind of language the market was looking for and bank stocks immediately hit the skids, taking broad market sentiment sharply lower as well. This statement raises the risk of more widespread and intensifying runs on vulnerable banks, with unpredictable speed. The situation will of course only be allowed to get systemic up to a certain point before intervention arrives to save the day, but the speed and path to some new crisis apex is completely unpredictable. And most importantly, the credit tightening this will bring has likely brought forward the US recession by at least 3-6 months and aggravated its potential severity.

The Yellen rhetoric revived the US dollar a bit late yesterday from its low level, even if the USD dropped again overnight (in part on hopes for the Chinese re-opening getting traction now). Today in Europe, the greenback has in turn unwound a considerable portion of the overnight losses. A US crisis is a difficult thing for currency traders to deal with: yes it impacts Fed rate expectations and is more negative at first blush for the US specifically, but financial conditions deteriorating in the US won’t stay bottled up there, nor will forward concerns for the US economy. The USD can clearly still find bids if sentiment wobbles badly, and there are justifiable concerns that some of the dynamics for banks are not unique to the US. This is quite clear in the impact on bank shares everywhere.

Chart: EURUSD
EURUSD shot up to well above 1.0900 yesterday from a base below 1.0800 as the FOMC statement release provided lift. Then, we saw considerable volatility on the Yellen statements on not insuring all bank deposits, before a brief new spurt higher overnight and then erasure of that move in Europe today. A rocky ride indeed!. European banks have not escaped negative pressure and also bear watching in the EURUSD equation. For now, I am far from convinced of any notable upside potential if we are on the cusp of new turmoil here. Technically, the rally needs to hole 1.0750 or so to keep the 1.1000+ focus.