Global Market Quick Take: Europe – March 14, 2023

What is our trading focus?

US equities (US500.I and USNAS100.I): has the dust settled post SVB Financial bailout?

Yesterday’s session saw big moves across US government bonds with especially the US 2-year yield declining 60 basis points as many corporates likely converted deposits into short-term bonds to reduce deposit risk. In equities mega caps were seen as safe havens with Apple shares gaining 1.5% while the broader S&P 500 Index was flat, and the Russell 2000 Index was down 1.5%. US financial conditions tightened to the tightest levels since late September and thus under those circumstances the S&P 500 Index should be trading closer to 3,600 than the close of 3,855 yesterday. Moves in times of crisis are always exaggerated and often not consistent so investors should continue to be cautious and not celebrate too early despite equities help up yesterday. The key indicators to monitor remain US bond yields, USD, FRA-OIS spreads (interbank stress), VIX, credit default swaps, and banking stocks.

FX: USD weakens as market prices imminent end of Fed hiking cycle

The USD continued to slide on Monday as US yields at the front end of the curve suffered an historic collapse, with Fed expectations revised lower (read below), although a floor in US rates was found in early Asian trading near 4.00% for the US 2-year yield. AUDUSD touched highs of 0.6717 late yesterday before reversing to 0.6650. GBPUSD found resistance ahead of 1.22 and focus turns to labor market data in the UK today before the budget announcement tomorrow, although incoming data feels suddenly less urgent than just a week ago, given the uncertainty the turmoil in the financial sector has generated since late last week. EURUSD touched 1.0750 with a 50bps rate hike still on the table this week from the ECB, although the probability for a hike of that size has dropped significantly, and ECB tightening expectations have seen a sharp downgrade since late last week. JPY and CHF continued to outperform, with USDJPY staying below 134 and USDCHF testing support at 0.91.

Crude oil tests strength of support near bottom of current range

Crude oil prices closed lower by 2.5% on Monday as banking sector concerns continued to challenge growth and demand dependent commodities from cotton and copper to crude oil. However, expectations of a less aggressive Fed monetary policy helped crude oil find support with WTI and Brent both finding support in the bottom 20% of their current ranges. In Brent, the prompt month backwardation remains elevated around 50 cents while the contango in WTI has not widened despite the current weakness, both signalling a discrepancy between current robust fundamentals and the overall weak sentiment. Ahead of today’s US CPI print, OPEC is scheduled to issue its monthly market report, while the International Energy Agency will follow on Wednesday.

Gold and silver benefitting from the yield collapse

Gold broke above $1900 barrier on Monday as flight to safety continued despite the efforts of US regulators to reduce the risk of contagion from the SVB collapse. The massive drop in 2-year Treasury yields of the order of 60bps as well as market now pricing in as many as four rate cuts this year (from four hikes less than a week ago) have seen the dollar come off considerably from its highs and brought the precious metals back in focus. Since the SVB news broke late Thursday, gold has gained 4.2% while silver has added a massive 8.5%, and with several rate cuts now priced in, and short end yields unlikely to continue their decline, the risk of a profit taking ahead of the CPI print has risen. Support levels that may get challenged in gold are 1900 followed by 1890 and 1872.

Copper looks to China for support

Copper trades back above $4 after managing to find support around $3.94, the December high. With the arrival of the peak season and the drop in copper prices, consumption in China is expected to continue to recover, potentially offsetting growth concerns elsewhere

Massive bull steepening in US Treasuries as investors flocked to 2-year Treasuries

On the back of U.S. regional bank turmoil, investors quickly repriced the front end of the Treasury curve and removed additional future rate hikes in this tightening cycle. Investors flocked to 2-year Treasuries in safe-haven bids and traders closed out curve-flattening positions. Yields on the 2-year plunged 61bps to 3.98% while the 10-year yields fell “only” 13bps to close at 3.57%. The 2-10-year curve steepened to -46bps, after hitting as inverted as -110bps last week.

What is going on?

Fed launches SVB probe as bank stocks tumble the most since the Covid-19 crash

The Federal Reserve will launch an internal probe to the supervision of Silicon Valley Bank after its collapse sparked criticism by the central bank oversight. The KBW Bank Index declined 12% yesterday extending last week’s rout that saw the index slide 16%. In biggest declines were among banks such as First Republic Bank (-62%), Western Alliance Bancorp (-47%), and California-based PacWest Bancorp (-21%) as depositors and investors were nervous about smaller financial institutions. Larger financial institutions were not immune to the risk-off with Charles Schwab shares declining 12%.

Credit Suisse has found material weakness in financial reporting

The Swiss-based investment bank was forced to postpone the release of its annual report last week due to US regulators and the morning the bank says that it has identified material weaknesses in its financial procedures for 2021 and 2022. The bank is working on remediating those errors. Credit Suisse 5-year CDS prices hit a new all-time high yesterday at 485.

Bank worries bring a significant shift in Fed expectations

Bonds continued to soar as markets digested the measures of the US regulators to stem contagion from the collapse of SVB. But that continued to complicate the path of monetary policy with the Fed having broken something. As markets continued to re-assess the path of monetary policy from here, 2-year Treasury yields plunged 61bps to below 4%, the biggest one-day slump in four decades, while 10-years dropped 16bps. The CME FedWatch tool now shows a 35% chance of no move from the Fed next week, and 65% probability of a 25bps rate hike. Fed Funds futures are now pricing in a terminal rate of 4.8% as early as May (down from 5.7% in July earlier) and as much as 100bps of rate cuts this year (compared to one 25bps rate cut expected last week).

What are we watching next?

US CPI will still get some attention, even if incoming data’s importance has fallen sharply

US inflation has been the talk of town for several months now, although the focus has lately turned chiefly to financial contagion risks that may stop the Fed from switching back to a higher rate hike path trajectory. In fact, several banks are now calling for a pause next week, with one also expecting a rate cut and an end to quantitative tightening. Still, the US February CPI – due to be released today – will be a big test after last month’s print reversed the disinflation narrative in goods inflation and continued to point at sticky services inflation. Headline consumer prices are expected to rise +0.4% m/m in February, cooling slightly vs the +0.5% in January, with the annual rate seen easing to 6.0% YoY from 6.4% previously. Core CPI is expected to rise +0.4% m/m in February, matching the January pace, though the annual rate is expected to fall to 5.5% y/y from 5.6% in January. Despite the SVB’s failure, we still believe the February CPI release will be particularly relevant for the FOMC’s March policy decision as the Fed may try to pretend that it can focus on business as usual. Evidence of economic resilience and persistent price pressures would prolong the Fed’s tightening cycle. However, by year-end, we expect the U.S. economy will start to experience more significant disinflationary pressures.

NFIB survey for February

Given that small businesses are particularly sensitive to domestic economic dynamics, sentiment among small business owners will provide an update on inflationary conditions and the labor market situation.

Earnings to watch

Volkswagen earnings are the big focus today at 9:00 CET but VW’s investment plans have already been surfaced increasing to €180bn in investments during 2023-2027 which is 13% higher than previously announced and with 70% going to EV. Next key US earnings are Adobe and Lennar tomorrow with analysts expecting Adobe’s revenue growth at 9% y/y which is unchanged from a year ago suggesting the growth rate is stabilising. Analysts are also expecting Adobe to show meaningful improvement in operating income as the software maker has reduced costs. Lennar is expected to report -3% y/y and –41 q/q revenue growth for FY23 Q1 (ended 28 Feb) and a significant hit to EBITDA at $725mn down from $1,527mn.

• Tuesday: Foxconn, Volkswagen, Generali
• Wednesday: Constellation Software, BMW, E.ON, Ping An Insurance, Prudential, Inditex, Adobe, Lennar
• Thursday: Verbund, Rheinmetall, KE Holdings, Enel, FedEx, Dollar General
• Friday: Vonovia

Economic calendar highlights for today (times GMT)

During the day: OPEC’s Monthly Oil Market Report

1230 – US Feb. CPI

1230 – Canada Jan Manufacturing Sales MoM

2030 – API's Weekly Crude and Fuel Stock Report

2120 – US Fed’s Bowman (Voter) to speak