More US bank casualties in the spotlight driving Banks down and weaker US equities overall, adds to the case of Fed being done with the hiking cycle. Market has increased conviction that the Fed will be forced into easing in second half. Curve steepens

More US bank casualties in the spotlight despite the Fed’s claim of “sound and resilient” banking system. Market more confident that the Fed is done hiking and easing will ensue over the second half.  Curve steepens further. Market sees ECB update as less hawkish than expected, sending European rates and the EUR lower. NZD outperforms for no obvious reason, peaks just under 0.63. NZ curve lower and steeper on global forces.

Yesterday, an hour after Fed Chair Powell said the US banking system was sound and resilient, another regional bank, PacWest Bancorp looked like the next candidate bank to fail, falling as much as 60% in after-hours trading after reports of it considering a breakup or a capital raise. Its stock is down over 40%. Overnight, Western Alliance plunged 60% after the FT reported it too was exploring strategic options including a potential sale. The company denied the report and the share price recovered half of those losses. First Horizon fell 35% after a deal with Toronto-Dominion was scrapped with a cloud over getting regulatory approval. The S&P500 currently shows a fall of 0.7%, with Financials acting as a drag on the market, with Banks down 3%.

So the fate of three more US regional banks hangs in the balance and there are plenty more on the watchlist.  The banking sector turmoil and likely resulting deterioration in lending conditions add to the case that the Fed is now done on the tightening cycle – alongside smoke signals around a pause in policy given by the Fed yesterday – and raises a question over whether the Fed has gone too far with its 500bps of hikes. Something “breaks” after every major tightening cycle. Smaller US banks are under the pump and concerns about the commercial real estate market continue to bubble under the surface.

The market is already eyeing up the first easing of the cycle and prices in a small chance of that happening at the next meeting – some “insurance” being bought in case something really bad happens between now and the next meeting.  At one stage a full 25bps cut had been priced by the July meeting, but that has currently been pared back to 18bps. Somewhere between 3-4 rate cuts have been priced by the end of the year.

The US 2-year Treasury yield fell to as low as 3.65%, but the fall has since been moderated to 3.73%, down 8bps for the day, adding to the 34bps fall over the two days before and immediately after the Fed’s meeting. There has been less volatility in the 10-year rate, trading 12bps range and currently up 2bps at 3.35%. In terms of the 2s10s curve as an indicator of recession, it is curve steepening that gives the best signal after inversion. Pre-Silicon Valley Bank failing, the 2s10s spread was trading at minus 108bps and since then the curve has steepened significantly to minus 38bps, giving a pretty clear signal of imminent US recession and especially when viewed against other leading indicators. A Bloomberg analysis of past cycles shows that when both the 2s10s and 5s30s curve steepen by at least 50bps, as has already happened, the median change in the Fed Funds rate over the ensuing 6-months is a cut of 100bps, so current market pricing is consistent with history.

As well as the ongoing concerns overhanging the US banking sector, the ECB latest policy announcement delivered the widely expected dialled-down 25bps hike to 3.25% in the deposit rate and adding that it would stop APP bond reinvestments by July (equivalent to QT of €25bn per month, raised from the current pace of €15bn per month). While guidance on future rate hikes in the Statement was fuzzy given the inclusion of a comment on past rate increases “being transmitted forcefully to euro are financing and monetary conditions, while the lags and strength of transmission to the real economy remain uncertain”, President Lagarde made it clear that there was more ground to cover “and we are not pausing…that’s extremely clear”.

European rates and the euro were volatile after the announcement, with the net result being lower rates and a weaker EUR, so the market ultimately seeing the ECB as less hawkish than expected.  German Bund yields have fallen more than seen in the US, with the 2-year rate down 17bps and the 10-year rate down 6bps. EUR has been the worst performing of the majors, down 0.6% overnight to 1.1020, against a flat GBP.

JPY has been well supported on the lower rates backdrop, seeing USD/JPY down towards 134. For no obvious reason, the NZD has been the best performing of the majors overnight, up 0.6% and finding some resistance just below 0.63. The AUD hasn’t made much progress overnight after the gain during NZ trading hours, so NZD/AUD broke above 0.94 but has since retreated a little. The NZD’s outperformance sees NZD/GBP back at 0.50 and NZD/EUR over 0.57.

NZ rates were dragged lower yesterday by global forces along with some curve steepening. The 2-year swap rate fell 10bps to 5.06% while the 10-year rate fell 4bps to 4.15%. The NZGB market had some supply to indigest which resulted in greater curve steepening.  While short-end NZGBs fell 8bps, the 10-year rate fell just 2bps to 4.11% and the ultra-long bonds rose 3-4bps. Australian bond futures have rallied overnight, with the 3-year rate down 11bps in yield terms and the 10-year rate down 5bps, setting the scene for lower NZ rates on the open.

Economic data have been a side issue to the other events going on in the market noted, but for the record, US initial jobless claims rose 13k to 242, with leading indicators suggesting plenty more upside ahead over coming months. Quarterly productivity data are volatile, but the combination of weak GDP growth and robust employment growth sent productivity down 2.7% at an annualised rate in Q1, more than expected.

In the day ahead the RBA releases its statement on monetary policy which will flesh out the view we heard from the Board and Governor Lower earlier in the week. Focus tonight will be on the US employment report, with the consensus expecting a further moderation in non-farm payrolls to 180k and small uptick in the unemployment rate and steady wages inflation. The post-FOMC speaking circuit gets underway with hawk Bullard discussing the economic outlook.