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Fundamental Analysis

Temporary First Republic-Related Stress to Fade Further

Temporary First Republic-Related Stress

Temporary First Republic-Related Stress to Fade Further

Shares of First Republic remain on a slide, but the spillover to other markets was much less than Tuesday. The new sell-off in the stock came after CNBC reported that the U.S. government is currently unwilling to intervene on behalf of the bank. Advisors to the bank are working on a solution that includes trying to raise capital after major banks helped restore confidence in the lender (as they had previously tried to do by depositing several billion dollars with the troubled lender). The main U.S. stock indexes opened with slight gains, but only the Nasdaq managed to hold them until the closing bell (+0.5%). The main European indices lost 0.5% to 1%. Technical factors also play a role after the EuroStoxx50 hit the highs for the year and resistance around 4400. U.S. stock futures are again positively oriented after-hours this morning after the strong meta results.

Core bonds tried to build on Tuesday’s gains but threw in the towel in the U.S. session. U.S. yields rose 4.5 to 5 basis points across the curve. Changes in the German yield curve ranged from -3.5 basis points at the front end to +4 basis points at the very long end. Economic data (disappointing U.S. core consumer goods) played no role in yesterday’s trading. The dollar returned to weakness, with EUR/USD temporarily surpassing yearly highs and making a new high at 1.1095. The pair eventually closed at 1.1041. Similar technical EUR accelerations were seen and held against currencies such as AUD, NZD and CAD. The EUR/SEK move was triggered more by the Riksbank’s dovish 50 basis point rate hike.

Focus now turns to GDP and inflation numbers today and especially tomorrow. Belgian inflation kicks off the national European releases today with the focal point tomorrow at French/Spanish/German inflation figures. The US eco calendar contains US Q1 GDP data today and March PCE deflators, Q1 employment cost index and Chicago PMI tomorrow. The data won’t derail Fed plans to lift policy rates by 25 bps next week, but could make or break our base case for a 50 bps ECB hike. Apart from EMU inflation, we’ll see Q1 GDP and the ECB’s credit and lending survey as well ahead of Thursday’s policy meeting. Overall, we expect the temporary First Republic-related stress to fade further with especially European yields supported by the upcoming ECB meeting. The narrowing short term yield differential between the US and Europe should keep EUR/USD supported as well.

The US House of Representatives yesterday passed a bill to raise the government debt ceiling currently at $31.4tn. The vote passed with only a narrow majority of 217-215 and is seen as a political victory for the Republican House speaker, Kevin McCarthy. The House Bill would raise to borrowing authority by $1.5tn or being extended till March 2024, whichever comes first. However, the bill also includes spending cuts that are unacceptable for the Democratic party. So, it won’t pass in Senate or meet a veto from President Biden. The White House press Secretary already indicated that Biden won’t approve the spending cuts. As the stalemate persist, the US government is at risk of defaulting on its payments somewhere on summer (potentially end July) depending on the inflow of tax receipts.

Minutes of the previous Bank of Canada meeting showed that immediate focus of the decision was on whether to increase the policy rate or keeping it unchanged at 4.5%. As part of this discussion, the governing council also considered how long the policy rate would need to remain elevated in order to return inflation to target. Economic resilience and persistence of elevated core inflation, concern that the evolution of inflation from 3% to 2% in H2 2023 and 2024 could prove more difficult and the need to be forward looking and not wait too long to ensure that monetary policy was restrictive enough were arguments to raise rates sooner rather than later.

The case to maintain the policy rate at 4.5% reflected the Governing Council’s view that headline inflation is coming down quickly in line with the Bank’s forecast and that more evidence would be needed to assess whether monetary policy was sufficiently restrictive. The GC agreed that it was important to continue to signal that it was prepared to increase the policy rate further if needed. It also assessed that cutting rates later this year isn’t the most likely scenario.