Fears of tightening financial conditions leading to a recession are driving traders to rethink their risk exposure and seek out safety in the stock market. That said, the dollar should outperform the rest of the currencies even with Fed’s tightening cycle moving to an end.

The bank profitability crisis has become a solvency crisis because of the involvement of some US and European officials. This will act as a catalyst for a substantial tightening impulse in financial conditions.

The repositioning started about two weeks ago when the problems in the US banking system became clear with the collapse of Silicon Valley Bank. The shift might look and feel violent at times, not just because the financial sector is at the centre of it all but also because the stock market had rallied to start the year. That is now being quickly unwound.

Three Federal Reserve policymakers expressed confidence in the actions taken to bolster the financial system and stressed the need to curb high inflation despite concern over banking strains.

Echoing Chair Jerome Powell’s determination to restore price stability, the officials on Friday said last week’s interest-rate increase was needed to rein in an economy running hotter than anticipated. St. Louis Fed President James Bullard also said that he now forecasts raising rates to 5.625% this year, which is 50 basis points more than the median projection of his colleagues.

Even as stocks rallied on Friday, banks and other growth-sensitive sectors tumbled, with energy stocks falling as West Texas Intermediate crude dipped below $70 per barrel gain. Autos and miners were among the worst performers, and commercial real estate shares slumped. Investors instead dashed for industries perceived as more resilient to economic downturns, including food, pharma and telecoms.

On the other hand, foreign central banks liquidated Treasury holdings at the fastest clip in nine years and tapped a key Federal Reserve facility to raise cash as banking stress roils markets.

Fed data showed official foreign holdings of Treasury securities fell by $76 billion in the week through March 22 to $2.86 trillion. That is the largest weekly decline since March 2014.

This would be negative news to US bonds and push the yield higher, causing the dollar to increase.

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Fullerton Markets Research Team
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