Last week was meant to be dominated by the US employment report release at the end of the week. While it duly delivered another strong net payrolls gain, which was in excess of 300,000 in February, the markets had been distracted by the news around difficulties at SVB (Silicon Valley Bank), which was then forcibly taken over by the FDIC (Federal Deposit Insurance Corporation) on Friday, and then the closure of Signature Bank by regulators on Sunday. This has prompted a significant re-pricing of the interest rate rises now expected from the major central banks at their March meetings. Markets now expect the ECB (European Central Bank) to potentially deliver an interest rate hike of less than 50 basis-points, when only a few days earlier 50 basis-points was viewed as a certainty. Markets now think the Federal Reserve will deliver possible rate cuts as early as July or September, with only a 50% chance of a 25 basis-point hike in March. As for the Bank of England, the markets are pricing less than a 50% risk of a 25 basis-point rate rise. 

With all of these moves taking place despite the strength of the headline US labour market data, it would appear than the fundamentals are taking a backseat while the markets wait to see how the authorities intend to resolve the current problems with some of the US banks, and restore confidence to businesses, households and the banking system. 

The UK government releases its Budget update (or Spring Statement) on Wednesday amidst the turmoil in financial markets, and with the UK economy looking likely to be in recession over the course of 2023. Can HM Treasury and the Chancellor provide some crumbs of comfort to households, businesses, and the public sector? We could see the Chancellor earmark more funding for the NHS and Defence Department, to combat the backlog on waiting lists with the Health Service and offer additional support to Ukraine in its fight against the Russian incursion across its borders. There might also be a delay to the reversal of the 5p fuel duty cut, and an extension to the £2,500 energy price cap, the latter of which will cost the Treasury far less than expected in any case. However, there are unlikely to be wholesale cuts to household or business taxes, in my view. 

As for the other big event of this week, the ECB Governing Council monetary policy decision, the greater market uncertainty gives the European Central Bank an easy out, if they want it, to deliver a smaller rate increase. With consumer price inflation coming down, albeit slowly, and signs of a collapse in producer price inflation, the ECB could do less, but that would be a negative as far as how the EUR performs, in my view. 

The current volatility in FX markets is because the markets aren’t sure of how much further there is to run for the current crisis in the US banking system. However, I would offer a note of caution with regard to the higher moves seen in GBPUSD and EURUSD, in that the reasons for selling the US dollar might not be as clear cut as they first appear. While this could lead to a lower US interest peak, there are similar arguments for the UK and Euroland. The squeeze on the US banking sector could also mean that the international availability of US dollars reduces as well. 

In short, I am not convinced that there is persistent upside in EURUSD, GBPUSD or any other major currency against the US dollar in the longer term, since these sorts of crises have been seen in the past, and it tends to prompt a positive flow into US assets as investors seek ‘return of’ rather than ‘return on’ investment. 

Recent moves in emerging markets have copied what has been seen in major currencies. The dollar has been sold off, but I think we are seeing that sell-off driven more by short-term interest rate moves, rather than any medium to long-term thinking about what this will mean for financial stability and market liquidity in these emerging economies. We could easily see a reversal of these gains as the financial stability of these banking systems come in for similar scrutiny, and there is a greater conflict in terms of additional monetary tightening from central bankers. 

With no significantly important central bank meetings due outside of the major economies, all eyes remain on efforts to restore order to the markets.