Global Market Sentiment Sours Despite UBS & Credit Suisse News

OVERNIGHTAlmost all major stock indices are trading lower across the Asia-Pacific region, while drops in equity futures pointed to lower opens for the major US and European benchmarks. Market sentiment remains soft despite news over the weekend that UBS had agreed to buy Credit Suisse, while the Fed and five other major central banks announced coordinated action to boost liquidity in US dollar swap lines.THE DAY AHEADWhile events in the banking sector continue to drive significant swings in financial markets, the big challenge for central banks centres around gauging how much recent turmoil will impact economic activity and inflation and the implications that has in terms of the appropriate setting for monetary policy.

Little more than a week ago there was speculation that the US Federal Reserve would use next week’s policy update to signal a re-acceleration in the pace of interest rate increases by hiking by 50 basis points rather than repeating the 25bp rise seen in February, while also likely signalling a higher terminal interest rate. Now markets are looking for at most a 25bp hike and are pricing in significant rate cuts by year end. Interest rate expectations have also softened in the UK and the Eurozone although in the case of the latter, rates are still priced to be above current levels at year end. This is the second time that interest rate expectations have shifted markedly in early 2023 and a key question is whether this latest move will prove any more enduring?

Last week, the Eurozone Central Bank was the first major central bank to update monetary policy following the most recent developments. There had been some speculation beforehand that they might opt for a smaller interest rate rise but instead they chose to proceed with the 50bp hike they had been flagging since their previous meeting. However, they did temper their forward guidance on rates replacing their previous explicit indications that they would rise further with a more conditional set of “data dependent” criteria.

The lack of any key data releases today means that there is little to distract markets’ attention from the ongoing banking sector situation. However, ahead of key decisions from the US Federal Reserve (Wednesday) and Bank of England (Thursday), comments from ECB President Lagarde later today (14:00 GMT) may provide some insight into how she views recent events as having altered the overall outlook for monetary policy. The ECB’s Centeno is also set to speak at 14:00 GMT.MARKETSAlongside the fall in equities, rising risk aversion has also led to further falls in global government bond yields. The 2-yr US benchmark sovereign bond yield has fallen below 3.70%, and to its lowest level since last September, while 2-yr German Bund yields fell 24bp on market open. Commodity prices have also softened with Brent and WTI crude prices dropping to levels last seen in late 2021.