Daily wrap: Currency war triggers stock market divergence as banks drop

European markets lost ground on Thursday with banking shares as well as top European exporters leading declines after the Federal Reserve stood pat and kept US interest rates unchanged.

UK & Europe

European markets lost ground on Thursday with banking shares as well as top European exporters leading declines after the Federal Reserve stood pat and kept US interest rates unchanged. The Fed backing off from raising rates in combination with other central banks cutting interest rates has rekindled concerns of a margin-squeeze for banks.

The euro gaining ground against the dollar has triggered a divergence in the performance of US and European stocks. If EUR/USD really has bottomed, the repatriation of foreign earnings into more dollars is beneficial for US multi-nationals to the detriment of European competitors. A more dovish Fed unwinds some of the export advantage for European companies that came about because of accommodative ECB policies.

The Swiss National Bank lowered its growth and inflation targets and the Norges Bank cut interest rates to 0.25%. The Norwegian central bank even went so far as to signal a willingness to try negative interest rates. A move to NIRP in Norway would just put it in line with Sweden, Switzerland and Eurozone countries. There is either a coordinated move by central banks to support global growth or we’re on the verge of a currency war.

The STOXX Europe 600 Bank index sank with multiple Italian bank stocks getting halted as Barclays, HSBC and RBS sat near the bottom of the FTSE 100.

It was the Bank of Japan that triggered the last big bank stock sell-off with a shock move to negative interest rate policy. Following a dovish whitewash from central banks over the last twenty-four hours, including a hint at negative rates from Norway, the next run on bank stocks could be underway.

Bank stocks remain some of most heavily shorted, which explains an outperformance as markets have risen since the February 11 low. The short interest makes banks very vulnerable in the next market downturn. That’s especially true if it is central bank’s incapacity to normalise interest rates that’s the trigger.

UK stocks outperformed those in the continent thanks to a gain in resource shares which have benefitted from a rally in dollar-denominated commodities following the Fed meeting.

 

US

US stocks rose in early trading on Thursday as multinationals and energy stocks led the gains at the prospect of a cheaper dollar whilst financials lagged as interest rates look set to remain low.

Gains in the Dow Jones Industrial Average took the US benchmark just shy of its year-to-date flat-line

 

FX

The US dollar was down across the board in the wake of lowered forecasts for the pace of rate hikes from the US Fed. The FOMC backed up the lowered guidance with cautious comments as it held off on raising rates in March. The Fed has offered no clear signal of when the next one might come but if it is to raise two more times this year, then a hike in June would be necessary before US presidential elections.

Other central banks were powerless against the Fed on Thursday. The Norges bank and Bank of Indonesia both cut rates while the Bank of England and SNB were dovish, but all of the respective currencies rose against the dollar.

Core Eurozone CPI rising above consensus to 0.8% y/y is likely to fuel more euro strength since it undermines the need for any new measures from the ECB.

The Bank of England voted 9-0 to keep interest rates unchanged. The central bank went so far as to specifically reference the Brexit referendum as a headwind for the UK economy, suggesting it could cause a slowdown in spending and economic growth.

 

Commodities

Gold has found its lustre again, gaining over $40 per oz in the last two days whilst silver has broken out to its highest since October. Precious metals are getting a double bump from a dovish Fed which makes non-yielding assets relatively more attractive and a sharp drop in European equities which is creating a demand for havens.

Oil prices continue to gain ground after producers agreed on a meeting next month to discuss an output freeze. Both Brent and WTI crude contracts have made fresh three-month highs.

 

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