The EUR/USD is this week’s key FX pair to watch.
- Will the Fed hike interest rates at all?
- SVB root cause behind bonds, risk sell-off
- Attention will turn to US CPI and ECB meeting next
- EUR/USD breaks 1.07 resistance
With the US inflation data and European Central Bank policy decision to come later this week amid all the uncertainty from the SVB fallout, the EUR/USD is clearly one of the most important currency pairs to watch this week.
Will the Fed hike interest rates at all?
The swift collapse in bond yields as a result of the SVB fallout has raised serious doubts about whether the Fed will raise interest rates at its March 22 meetings, since rising borrowing costs was the reason behind SVB’s failure. To give you an idea of how fast things have turned, the US two-year bond yield was set for the largest two-session drop since 1987! This is clearly a reflection of investor concerns that there may well be more collapses in the global financial sector.
The dilemma for Jay Powell is that if he opts for more hikes, there is a risk that more regional banks might collapse, while not doing anything could exacerbate inflationary pressures again. Judging by market reaction in the last couple of days, the market feels like whatever they do, the economy is going to take a hit regardless. But one thing is clear: the market is no longer certain interest rates will be pushed much higher from here. In fact, investors have started the to price in rate cuts in Q4.
Here’s what the market has priced in for the Fed’s next three meetings compared to just a week ago:
As per the above illustrations, the market is now expecting only a 25 basis points – if that – at the Fed’s March 22 meeting. Investors are 35% confident that the Fed will decided to leave rates unchanged and then raise rate sone more time by 25 basis points in one of the subsequent meetings by 25 basis points.
SVB root cause behind sell-off
Nearly all the volatility we have seen over the past few days have been created due to the fallout from Silicon Valley Bank (SVB). SVB specialised in lending to technology companies, but it failed to raise money to plug a loss from the sale of assets affected by higher interest rates. As a result, it was shut down by US regulators on Friday, representing the largest failure of a US bank since 2008.
All attention on US CPI next
The latest Consumer Price Index will be published on Tuesday, March 14 at 12:30 GMT. The CPI comes after the Fed Chair Powell warned just last week that the central bank could ramp up the pace of rate hikes and could keep a tight policy in place for longer. This sent the odds of a 50-basis point rate hike for the March 22 meeting to above 70%. However, those expectations have since been shattered due to the fallout from SVB crisis.
The market is now worried that if the Fed continues with its rate hikes, more problems might surface as people struggle to pay debt amid high interest rates. Those concerns may intensify if the Fed opts for what would be a surprise 50 basis-point rate hike later this month. But it looks more likely that it will either opt for 25 bps or no hike at all. To save it from embarrassment of making a complete U-tun, the Fed would be hoping that CPI comes in significantly weaker on Tuesday.
ECB policy decision comes at a tricky time
The European Central Bank will decide on monetary policy on Thursday, March 16 at 13:15 GMT. This meeting could not have come at a worse time. Granted, interest rates in the Eurozone are nowhere near as high as in the US, but credit default swaps for some troubled European lenders have been on the rise owing the SVB fallout. Still, inflation is too hot for the ECB’s liking not to tighten its belt further.
Most analysts are expecting the ECB to raise the main refinancing rate by 50 basis points to 3.5%, keeping up the 50-bps hiking pace for the third consecutive month. Since the ECB’s last meeting, Eurozone data has been mostly positive and core inflation rose to a fresh record high of 5.6%, even if headline CPI eased a tad to 8.5%. These inflation readings are way too high for ECB to be comfortable.
EUR/USD breaks 1.07 resistance
Ahead of the above macro events, the EUR/USD has broken above the 1.0700 resistance level owing to expectations that the ECB might tighten its policy more than the Fed over the next few meetings. The breakout has potentially paved the way for a run towards the next resistance level around 1.08 area – and possibly even higher, depending on the outcome of this week’s macro events.
The main risk for the EUR/USD right now is that if sentiment gets hurt so badly that the dollar finds support on haven flows. If the EUR/USD goes back below 1.0700 now and holds below this level, then this would put the bulls in a spot of bother.
Even so, the downtrend will not fully resume unless rates go below key support around 1.0500 this week. But if that level gives way, then we would expect to see follow-up technical selling towards the 200-day average and old support around 1.0340 next.
However, our base case assumption is that the EUR/USD will be able to climb higher as investors price out the risks of further aggressive rate increases from the Fed.
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