The European Central Bank (ECB) decision yesterday was important as it offered a first indication of what the banking stress meant for the monetary policy.
And it did not mean much – a relaxing news for markets.
The ECB chose not to fan the banking worries and went ahead and announced a 50bp hike at yesterday’s policy decision pointing at high inflation.
The opening sentence of ECB Chief Christine Lagarde’s speech was that the bank predicts ‘inflation to remain too high for too long’.
And indeed, the final CPI data due out today is expected to confirm a February inflation at around 8.5% – which is high, but not bad compared to double-digit levels printed a couple of months earlier, but core inflation is now at record, and it needs to be addressed.
Regarding the bank turmoil, Lagarde said that the European banks are strong and resilient, they have ample liquidity, and, in all cases, the ECB has a toolkit – other than the interest rates and broad monetary policy – that could help address liquidity issues if needed.
That was clear, and well played.
What was unclear however was, what will happen next to the ECB policy. Lagarde gave no indication on the future. She said the future decisions will depend on economic data.
The lack of conviction for further 50bp hikes is certainly what held the euro back from recording a better rally after the ECB’s 50bp hike yesterday.
The EURUSD gained ground, but the advance was barely noticeable. The next natural target for the bulls is the 50-DMA, which stands around the 1.0730 level, and whether the pair could break it depends on what will happen on the Fed front.
What will the Fed do?
The ECB’s clear focus on inflation, and not on bank stress, reinforced the expectation of a 25bp hike from the Federal Reserve (Fed) next week.
The ECB decision came as a hint that the Fed could also play down stress in banking sector, highlight that the liquidity issues could be addressed with available tools and keep focus on economic data.
At the wake of the ECB decision, activity on Fed funds futures gives more than 80% chance for a 25bp hike. This probability was around 65% before the ECB’s decision.
What does that mean for the US dollar? It probably means a further wind down of the early-year gains as we are now back to the scenario where the Fed would hike by a final 25bp and pause. That was the expectation as we stepped into this year, before the Fed’s peak rate expectations shot up to 5.6%. That bet is nearly dead. It could come back to life, but the impact of Fed tightening on banks could help to restrict borrowing from here and ease inflation, and need for further Fed action.
There’s your pivot, ladies and gentlemen.
Licking the wounds
The US bond markets are now licking the past week’s wounds. The US 2-year yield is up but remains well below the pre-SVB collapse levels. BoFA’s MOVE index, which is the implied treasury volatility, hasn’t been this high since the 2008 subprime crisis, which calls for caution.
Caution, but stock markets are on a full-cheer mood. European indices loved the dovish 50bp hike from the ECB yesterday.
Plus, the relief on Credit Suisse in Switzerland and the First Republic Bank boosted sentiment across the Atlantic as well. The Stoxx 600 bounced off the goal post and rebounded after testing the major 38.2% Fibonacci retracement on October to February rally, the S&P500 rebounded around 1.75% and closed the day above the 200-DMA, whereas Nasdaq 100 spiked nearly 1.70% higher, as Amazon, Alphabet and Microsoft jumped more than 4%, Nvidia gained above 5%, Intel above 6%, and AMD nearly 8% after US big banks decided to deposit $30 billion with First Republic Bank as a show of support.
Bitcoin – which tends to move closely with the tech stocks, rallied more than 30% since last week and is now above the $25K psychological level, looking for a further advance to the $30K mark.
Will the joy last? Jim Cramer tweeted ‘short this Nasdaq and invite me to your funeral’.
The volatility index on stocks is at reasonable levels, but a 4, 5, 6, 8% jump in big stock prices is a sign that volatility is threatening and calls for caution.
Anyway, the last trading day of a chaotic week could be a calm one (tough you never know !) Investors will monitor the US industrial production and the University of Michigan’s sentiment index, expect some further, upside correction in yields and pray that nothing major happens before next Wednesday’s FOMC decision.
