Australian dollar dumps as risk pumps

DXY was soft last night and EUR firm:

AUD fell:

Gold sagged and oil popped:

Dirt too:

But miners (NYSE:RIO) fell:

EM stocks (NYSE:EEM) firmed:

With junk (NYSE:HYG):

As Treasuries were murdered and the curve killed:

Stocks look like they want to break out:

As KRE (NYSE:KRE) finally caught a bid:

Deutsche discusses why DXY (and AUD) are behaving so strangely (some of the time) relative to other crises:

Usage of emergency Fed liquidity by US banks is higher than at the peak of the Lehman crisis. Interest rate volatility last week spiked to the highest on record. Yet one source of market stress has not arrived: a safe-haven demand for the USD. This is highly unusual. Previous periods with similar volatility including COVID and the GFC have been associated with at least a 10% rally in the dollar in just a few days.

Why is this happening and what does it mean about the future?

There is no dollar shortage in offshore markets. While cross-currency basis is widening in short to mid-dated tenors, overnight funding in FX markets remains  very well behaved and central bank dollar swap lines remain largely inactive. There is no immediate dollar cash crunch. While equities and European AT1 instruments have been under pressure, senior credit in banks – arguably a better measure of systemic risk – has not widened that sharply. The market is still not treating developments as a systemic event that challenges day to day bank solvency or funding.

The Fed is being repriced far more sharply than everywhere else. Over the last two weeks US 1y1y interest rate expectations have fallen by nearly twice as much as everywhere else. As Shreyas Gopal points out FX continues to follow relative rate moves relatively closely and the Fed repricing is allowing interest rate differentials to narrow against the USD. Unsurprisingly, the JPY has been the biggest beneficiary.

There is more pain in the onshore US banking system than elsewhere. US bank stocks have sold off more than in Europe or Asia over the last two weeks. A comparison of banks’ cost of funding versus rate of return on long-end assets points to US banks being significantly more challenged in their earning capacity due to a far more inverted curve (chart 2). Deposit outflows from US banks are more broad-based than Europe. Together with equity weakness, this suggest that the Fed hiking cycle is more likely to have a sustained negative impact on bank balance sheets and credit provision compared to the rest of the world.

We noted last week that a resolution to uncertainty out of the Swiss banking sector was more important in the near-term than the outcome of the ECB meeting. That this has now been provided and market measures of systemic risk remain well behaved is important for FX markets. The emergence or absence of systemic risk outside of the US remains the key variable for the currency market in the short-term.

But as soon as this question is resolved, the market will immediately turn to the bigger picture macro question: are developments over the last two weeks more likely to accelerate a dovish Fed pivot versus the ECB and everywhere elsewhere?

We continue to believe the answer to this question is yes.

Fair enough but that describes the end of just every other business cycle that I can recall. It’s always the Fed leading. It’s always the ECB that is hawkish for too long. It’s usually EMs that weaken last as trade shocks arrive.

I am not invested in forex at the moment because I can see there is some truth to the argument that DXY is higher than normal so it may be that it has less room as a safe haven.

But neither am I convinced that the safe haven role will not work this time.