Weekly Focus – Central Banks Hold Steady Course Despite Banking Jitters

After UBS’ takeover of Credit Suisse and the wipe-out of AT1 bondholders, risk sentiment remained on shaky grounds this week. Investors took courage from comments from European regulators that reiterated that common equity instruments are first in line to absorb losses before AT1s. Yields started to rebound and markets have now repriced the ECB peak rate back to 3.5%. As more time lapses (without more negative news on the banking turmoil), more focus will return to macro data – which still warrants further repricing higher in our view. President Lagarde delivered a fairly balanced speech at the ECB watchers conference, stressing that policymakers will maintain a data-dependent approach that allows it to respond to inflation risks, but also aid financial markets if threats emerge. She also repeated that if the ECB’s baseline holds there will be more ground to cover in terms of future rate hikes.

After ECB remained in tightening mode last week, also the Federal Reserve chose to hold a steady course this week and hiked policy rates by 25bp. That said, both the statement and Fed chair Powell’s comments were tilted to the dovish side, highlighting that the ‘recent (banking sector) developments are likely to result in tighter credit conditions for households and businesses and to weigh on economic activity, hiring, and inflation’. US Treasury yields declined again after the meeting and EUR/USD ticked higher. Equity markets came under renewed pressure after US Treasury Secretary Yellen commented that the US is not considering a ‘blanket insurance’ for bank deposits. For now, we stick to our call of a final Fed hike in May, and no rate cuts through 2023 (see also Fed review: A cautious 25bp hike, 22 March). Bank of England also hiked its policy rate by 25bp to 4.25%, after inflation surprisingly accelerated again in February (see also Bank of England Review – Set for another 25bp hike in May, 23 March).

Chinese President Xi Jinping concluded his three-day-visit in Moscow. During the visit China’s peace proposal was discussed, but also a deepening trade relationship. We have doubts that China’s peace proposal will gain traction, as it has been widely criticized by the US, and Ukraine and Russia are very far from each other in their individual demands. A key concern that could escalate global tensions has been whether China would deliver weapons to Russia, but so far there are few indications of this.

With the big central bank meetings out of the way, developments in the banking sector will continue to set the tone for markets in the near-term. In the US, focus remains on any signs of tightening bank credit standards, the use of Fed’s liquidity facilities and FOMC commentary. In light of ECB’s data-dependence, markets will also keep a close eye on the euro area HICP figures for March released on Friday. Despite a further decline in headline inflation to 7.9%, we expect them to show still a picture of strong underlying inflation pressures, with core inflation remaining unchanged at 5.6%. The official Chinese PMIs are also on the agenda on Friday. After the rebound in February, we look for a moderation in March, as the initial post-covid lift in activity is likely to fade. However, overall PMIs in both manufacturing and services should still signal above-trend growth, and thus a continued recovery.

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