Dollar stabilizes as shock from banking crisis recedes

By Geoffrey Smith 

Investing.com -- The dollar stabilized and the euro weakened in early trading on Tuesday in Europe, as the shock from the collapse of three U.S. banks in a week began to recede.

The signs of stress in the U.S. financial system have caused a sharp reappraisal of the outlook for interest rates across the U.S. and Europe since Thursday, with two-year yields in the U.S. falling by the most in any three days since the 1987 market crash. Whereas there was a broad consensus for a 25 basis point rate hike from the Federal Reserve next week, with 50 basis points seen as the next most likely outcome, most of the market now expects no change. Analysts at Nomura went as far as to predict the Fed will cut the target range for fed funds by 25 basis points.

Nomura's view remains a minority one, not least because U.S. inflation is still running well above target. The U.S. consumer inflation report for February is due at 8:30 ET (12:30 GMT) and is expected to show only a relatively modest drop to 6.0% from 6.4% in January. The monthly price dynamic is expected to weaken slightly to 0.4% from 0.5% in January. 

By 04:00 ET (08:00 GMT), the dollar index, which tracks the greenback against a basket of advanced economy currencies, was up 0.3% at 103.52. The dollar's gains came largely against the euro, which has outperformed since Thursday simply because the European Central Bank has all but committed itself to a hike of 50 basis points at its policy meeting on Thursday. That means that the key variable at the ECB meeting will be President Christine Lagarde's guidance for future meetings, which many now expect to be less hawkish than her most recent public comments. 

In her recent appearances, Lagarde has appeared to side more with hawks pushing for more 50 basis point steps later in the year. This now seems less likely, according to Berenberg Bank Chief Economist Holger Schmieding, not least because events in the banking system will cause financial conditions to tighten both in the U.S. and the Eurozone. 

"If the markets do more, the ECB has to do less," Schmieding said in a note to clients. 

The euro was down 0.3% at $1.0692, giving up some of the 2% rally over the last three days. The pound also weakened slightly after gaining nearly 3% against the dollar over the last week. By 04:00 ET, it was down 0.3% at $1.2148.

Sterling was still supported by labor market data showing a bigger-than-expected increase in employment in the three months through January that kept the jobless rate at a historically low level of 3.7%. Growth in average earnings weakened from the record levels it has posted in the previous two months. 

The Bank of England's next policy meeting is next week, a day after the Fed's. However, the pound has some event risk this week, with the government's new budget for the coming year due to be presented to parliament on Wednesday.