Yen eyes more gains as Fed balance sheet expands, bank turmoil brings dollar pain

By Yasin Ebrahim

Investing.com -- The turmoil in banking this week coaxed investors into the arms of the safe-haven yen at the expense of the dollar and many are calling for more of the same as the rewidening of the Fed’s balance sheet and the upcoming Federal Reserve decision points to more pain ahead for the dollar.

“We are maintaining a short USD/JPY trade idea,” MUFG said, targeting 129.00.

The yen, which racked up a 3% gain against the dollar this week, has been “one of the main beneficiaries so far from the loss of confidence in the health of the banking system,” MUFG added.

The concerns of a banking crisis -- brought on by the collapse of Silicon Valley Bank and Signature Bank -- over the past week triggered a rush to safe havens including gold, Treasuries and the yen as concerns about a contagion in the banking sector heated up.

The 2-year U.S. Treasury yield this week suffered its biggest three-day slump since Black Monday in October 1987 as investors piled into bonds and at the same repriced the Fed’s rate-hike path with cuts now forecast for the second half of the year.

The Fed, however, launched a new bank funding facility, allowing banks to receive loans up to one-year using qualifying assets including any underwater, or below par, bonds as collateral.

The lending facility will re-build bonds on the Fed’s balance sheet.

The move has not only blunted the Fed’s ongoing quantitative tightening program -- in which $95 billion of maturing bonds per month are allowed to mature – but triggered a rewidening of its balance sheet, likely keeping the pressure on the dollar.

“The rewidening of the Fed’s balance sheet and increase of USD liquidity are negative factors that are encouraging USD selling in the near-term,” MUFG said. The Fed’s balance sheet jumped by about $300B in the week to 15th March.

Much of the swelling of the Fed’s balance sheet was driven by a record $153B increase in borrowing from the Fed’s discount window, according to MUFG. But others expect it’s only a matter of time until an uptick in the Fed’s new lending program speeds up.

“The terms on this facility are so good that a significant take-up is quite probable,” ING said, adding that “once volumes build, more and more (mostly smaller) banks will likely use the facility.”

The Fed’s rate decision next week, meanwhile, isn’t likely to stop the rot in the dollar as some expect that the turmoil in banking, which has already tightened financial conditions, may sway the Fed away from maintaining its hawkish tilt.

“Higher borrowing costs and reduced access to credit mean a higher chance of a hard landing for the economy. Rate cuts, which we have long predicted, are likely to be the key theme for the second half of 2023,” ING said.

“Our overall preference is to remain defensive this month and maintain overweight positions in the Japanese yen,” it added.