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USD: Policymakers move swiftly to restore confidence

As of Friday's second-largest bank failure in history, US policymakers have taken swift action to restore confidence in the US banking system. Together, the Federal Reserve, US Treasury, and Federal Deposit Insurance Corporation have announced two significant measures. Firstly, they will ensure that all uninsured depositors of SVB will be made whole. This measure aims to address the fear of uninsured depositors, particularly in the venture capital/tech sector, who may have lost their deposits and subsequently pulled funds from other banks with high ratios of uninsured deposits (reportedly, 96% of SVB's deposits were uninsured). Additionally, the Fed has introduced a new liquidity programme called the Bank Term Funding Program (BTFP).

As someone who closely follows financial news, I've been keeping track of the recent developments in the US banking system. In response to the second-largest bank failure in history, policymakers have acted quickly to restore confidence. The Federal Reserve, US Treasury, and Federal Deposit Insurance Corporation have announced two crucial measures to address the situation. (read more here: Assessing the Silicon Valley Bank fallout | Article | ING Think)

Firstly, the authorities have decided to make sure that all uninsured depositors of SVB will be reimbursed. This step aims to tackle the fear of uninsured depositors in the venture capital/tech sector who might have lost their deposits and withdrawn funds from other banks with high ratios of uninsured deposits. In this case, reports indicate that 96% of SVB's deposits were uninsured. This measure is expected to alleviate the pressure on the banking system and prevent any further outflows.

Secondly, the Federal Reserve has introduced a new liquidity program, the Bank Term Funding Program (BTFP). This program enables eligible financial institutions to access dollar liquidity by pledging US Treasuries, Agencies, or Mortgage-Backed Securities as collateral. Importantly, the collateral values will be taken at par, meaning there will be no write-downs. This measure aims to address SVB's problem of needing to meet deposit outflows with sales of securities, which forced the bank to realize losses and burn through equity capital.

However, despite these measures, investors are closely monitoring US banking stocks to assess whether they have been enough to restore confidence. Over the weekend, another bank, Signature Bank in New York, was also taken into administration by US authorities, adding to concerns. The market has now scaled back expectations for this month's FOMC to a 25bp increase, with some high-profile names calling for unchanged rates.

Indeed, the pricing of the December 2023 FOMC meeting is now 75bp lower than in the middle of last week. Therefore, it remains to be seen whether these measures will be sufficient to restore investor confidence in the US banking system.

EUR: Spreads narrow markedly in favour of EUR/USD

I've noticed a significant change in the Fed policy curve. The two-year EUR:USD swap rate differentials have narrowed to under 100bp, which is the narrowest since October 2021. This change is positive for EUR/USD. Unless US banking stocks experience a massive rally today, indicating that US authorities have successfully contained the risks in the banking sector, I believe EUR/USD will continue to trend towards the 1.0780/1.0800 area.

Looking ahead to Friday, the European Central Bank policy meeting is expected to be challenging. Despite the potential for increased market volatility, the ECB will likely proceed with a 50bp hike to avoid exacerbating the current situation. It remains to be seen how the market will react to this decision, but I will be keeping a close eye on developments in the coming days. (read more here ECB preview: 50bp next week but how far will the ECB still go? | Article | ING Think)

GBP: Bailouts and budgets

From my analysis of the markets, I was surprised to see sterling perform better than anticipated on Friday. While many consider sterling a safe-haven currency, I struggle to share that view given the UK's large current account deficit and financial sector exposure. Instead, I suspect that deleveraging and short sterling positioning contributed to the currency's performance.

Today, all eyes are on the UK's response to SVB's UK arm and its support for the tech sector. Like the US, depositors in the UK will be made whole, and the government is looking to address the working capital needs of those exposed.

Despite the current situation, the market still expects the Bank of England to move forward with a 25bp hike on 23 March. However, this could be at risk of being priced out, as the BoE was already considering a pause.

Given these factors, I believe that EUR/GBP may retrace back up to 0.8900, while I would advise against chasing GBP/USD over 1.22. As always, the market can be unpredictable, and I will continue to monitor developments closely.

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