The US banking crisis initiated by the Silicon Valley Bank’s (SVB) crash has overwhelmed other market drivers. The shift in the momentum across all asset classes from bonds to equities to precious metals to currencies was swift and prompt as it was further followed by other banks like First Republic and PacWest, etc. along with the European banks like Credit Suisse who joined the league.
The turbulence couldn’t subside until the markets were assured that, “Markets can have confidence that the banking system is safe!” and the call to action was taken to protect them.
“Crises and Currencies, though the initials are common, the occurrence of the former would lead to a Crash in the latter- But it’s not the case with the Mighty Dollar!”
They say, “History is the best teacher…!” Let’s see what’s in the treasure!
As seen in the above graph, historically, since the 1990’s the Dollar has followed an appreciation trend during times of crisis.
Since the financial crisis, the wisdom has been that, during market turbulence, investors sell risky assets and turn to US Treasuries and the US Dollar.
Often the US dollar is a default safe haven for companies facing any domestic currency uncertainty, amid its status as the world’s reserve currency due to its domination for many international business deals.
The US Dollar’s safe-haven status is maintained by the reliability of the US Treasury to pay its investors. However, this time, the dramatic shift in expectations for the US Fed policy gave a potent shock, with reverberations throughout the capital markets, and as an initial knee jerk, the USD fell sharply from 105 to 103 levels.
Well, talking about the safe haven, gods own metal Gold is also likely to be set on fire, as historically it observed that, whenever global financial markets come under pressure due to a higher probability of a black swan event, Gold too always rallies.
This time, due to various reasons like central banks piling up gold reserves, flipping Fed hike expectations, geo-political concerns, etc., gold is likely to move higher toward $2050 once it crosses $1950 levels.
In Rupee terms, we expect it to move towards 61000-61500 levels in the near term. In the medium term, it could move towards 65000 levels.
Impact on Fed Policy and so the Dollar
Market narratives have changed hands frequently from hawkish to dovish on US Fed rate hikes due to rising financial-stability fears.
Last month the probability for an aggressive rate hike by 50 basis points was up by 75% and 25 basis points were fully factored in.
But due to recent turmoil, the markets have started to bet that the US Fed will pause hikes and begin pricing in cuts by 100 bps by year-end, which initially dented the dollar. Will be interesting to see whether sticky inflation will force US Fed to keep rates higher.
Inflation-focused Fed >> More Hikes >> Higher Dollar
Cautious Fed >> Pause Hikes >> Stable to weaker Dollar (Depending upon the stance of peer central banks like ECB and BoE)
Fears of further defaults >> Rate Cuts >> Knee jerk reaction – weaker Dollar (but later could rise due to safe-haven demand)
Well, clearly, it’s a win-win for DXY in any case if history is to be believed which can push the bars for dollars higher toward the 107-108 zone.
Therefore, organically, when the fiat rises the riskier currencies like EURO, GBP, and other Emerging market Currencies are bound to come under strain.
Impact on Majors- EUR and GBP
On the Euro-zone front, a critical difference between the European and US banking systems, which will limit the damage, is that European banks’ bond holdings are lower and their deposits are more stable as the regulations were made more stringent post the 2008 bubble burst.
Though rationally, the steps taken should be enough to stop any contagion from spreading and taking down more banks, which can happen in the blink of an eye in the digital age.
But contagion has always been more about irrational fear, so there is no warrant.
Hence, the central banks can become more cautious as seen in the latest ECB policy where the indication for further hikes was kept data dependent based on the evolving situation.
Nonetheless, with reduced hiking expectations from the ECB too, the EUR could fall back towards 1.0500 to 1.0350 levels. On the flip side, if 1.0750 will act as a strong resistance.
For GBP, a rise in a rival currency like USD, coupled with BoE’s already dovish stance hinted at the markets being data dependent, had already dented GBP.
Focus shall now remain on the tone for the upcoming monetary policy amid the contagion risk and fear of overtightening for the economy who is not used to such multi-decade high-interest rates.
Hence, the GBP is likely to resist around 1.2250 levels, and downside, a breakout below 1.20 levels can push the pair towards 1.1850-1.1650 levels.
Impact on Rupee:
As seen above, EM currencies generally have an inverse co-relationship with the USD, meaning when the dollar rises, EM currencies tend to fall.
During the height of financial crises, the currencies of all emerging market economies suffer extremely large declines against the dollar as witnessed by the 2008 financial crisis amid huge FII outflows taking place.
With weakening EM currencies, the Rupee is also bound to weaken. For now, the central banks across have become the currency manager and have insulated their currencies against the heat of the external environment by using the FX reserves and so did the RBI actively.
However, if the fear is high, sentiments are weak and FII outflows continue, the USDINR can break the 83.00 mark which so far has been protected by RBI.
A breakout there above could drive the pair to 84.00-84.50 levels in the medium term.
(The author is MD, CR Forex Advisors)
(Disclaimer: Recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of Economic Times)