Dollar Weakens As Fed Seen Jilting Its Hawkish Tilt

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Currency markets opened the new week mostly flat, after a tumultuous weekend that had witnessed the collapse of two banks in the U.S. However, anxiety was writ large ahead of an eventful week. Lined up for the week spanning March 13 - 17 were CPI readings from the U.S., interest rate review by the ECB, employment data from the U.K., updates on retail sales, producer price inflation, consumer sentiment and building permits from the U.S. as well as President Biden's address on the banking system and the Fed's closed-door emergency meeting.

As markets woke up to the new monster called interest rate risk that had dented the market value of banks' bond portfolios, shares of several regional lenders in the U.S. came under selling pressure. Concerns about the massive increase in interest rates over the past year and its inverse effect on bond prices threatened to get bigger and wider till several bigger banks chipped in to place a $30 billion deposit with First Republic Bank which was at the receiving end of investors' flak.

Amidst fears of a full-fledged banking crisis in the U.S., Switzerland-based Credit Suisse shocked markets with a "material weaknesses" flag that risked a banking crisis contagion to Europe and the wider world. The Swiss National Bank stepped in with a quick lifeline to Credit Suisse which did not suffice, and rival UBS was in less than a week forced to take over the bank at a heavy discount to its market value.

Meanwhile data from the U.S. showed that consumer price inflation eased as expected, triggering hopes of not just a pause by the Fed but also wild hopes a stunning Fed pivot. Producer price inflation and retail sales in the U.S. also dropped more than expected, driving up the clamor for the Fed to take cognizance of the recent developments and to also assess the cumulative effect of the recent rates hikes and monetary tightening before hiking further.

Amidst the above developments the U.S. dollar declined against major currencies. The Dollar Index (DXY) which measures the U.S. dollar's strength against a basket of 6 currencies declined 0.83 percent over the week, from 104.58 on March 10 to 103.71 on March 17. All this, after a turbulent week which saw the DXY range between a high of 105.10 and a low of 103.44. The DXY is currently at 103.32.

The euro appreciated 0.22 percent against the U.S. dollar over the course of the past week, with the EUR/USD pair rising to 1.0666 on March 17, from 1.0643 a week earlier. The ECB sticking to its earlier commitment to raise rates by 50 basis points came to the euro's rescue. The EUR/USD pair ranged between a high of 1.0761 and a low of 1.0516 over the week. The euro is currently at $1.0716.

The British pound strengthened 1.22 percent against the U.S. dollar over the week ended March 17. The GBP/USD pair which had closed at 1.2028 on March 10, strengthened to 1.2175 by the end of the following week. The pound ranged between $1.2205 and $1.2010 during the week amidst relief that the banking crisis did not spill over to the U.K. The pair has since increased to 1.2248.

Safe-haven yen emerged winner in the banking turmoil as the U.S. dollar depreciated 2.4 percent versus the yen over the week ended March 17. The decline in bond yields also eased the pressure on the new BoJ governor to dilute the accommodative stance. From the level of 134.98 on March 10, the USD/JPY pair strengthened to as much as 135.13 on Wednesday. The pair dropped to as low as 131.56 on Friday, before rebounding and closing the week at 131.79. The pair is currently at 131.66.

The AUD/USD pair increased 1.8 percent in the past week. From the level of 0.6577 on March 10 the pair increased to 0.6695 at the end of March 17. The Australian Dollar strengthened from the low of $0.6581 on Monday to touch the weekly high of $0.6726 on Friday. The pair is currently at 0.6716.

Amidst the banking sector crisis, all eyes are on the Fed and its interest rate review on Wednesday. Expectations that the Fed would prioritize financial stability over price stability have increased over the week. The new liquidity support measures introduced in response to the crisis in the banking sector which are bound to widen the Fed's balance sheet as well as undo some of the quantitative tightening is seen as indicative of the Fed's concern for financial stability. The crisis has undoubtedly clouded the interest rate hike outlook and added to the Dollar's weakness.

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