EURUSD awaits uncertain ECB decision amid Credit Suisse crisis

The European Central Bank is set to announce its rate decision at 13:15 GMT today (Thursday, March 16^th).

Most economists surveyed by Bloomberg expect a 50-basis point (bp) hike. However, the market’s forecasts, judging by the overnight index swaps (OIS), are pointing to a mere 14.5% chance of such an occurrence (50-bp hike), pointing to a 25-bp hike as the likelier outcome.

For context, this time last week, markets had priced in a 50-bp hike as a done deal.

And as the saying goes, a week is a long time in global financial markets.

And the market’s collective focus has indeed seen a dramatic shift since.

 

What’s changed the ECB calculus? Answer: Credit Suisse

Tracing its origins back nearly 170 years ago, Credit Suisse is the second-largest lender in Switzerland, while also operating in more than 50 countries.

Crucially, the Bank of International Settlements ranks Credit Suisse as one of the top-30 banks most important to the global financial system.

Here’s the recent series of unfortunate events for the Swiss lender:

• March 9^th: Credit Suisse is forced to delay the publishing of its annual report, after the US Securities and Exchange Commission queried said report.
  That sparked a run of 5 consecutive days of declines for Credit Suisse’s US-listed shares, resulting in a cumulative drop of 25.5% between the closing price on March 8^th through March 15^th.
   
• March 15^th: Ammar Al Khudairy, the chairman of Credit Suisse’s largest shareholder, Saudi National Bank, said that he would “absolutely not” make further investments into Credit Suisse.
  Those comments triggered a 14% collapse in Credit Suisse’s US-listed shares – its largest single-day decline (in percentage terms) since the 15.6% plummet on February 9^th, 2023.

 

To be clear, its financial woes have roiled on for years, including a CHF 7.3 billion loss in 2022 that wiped out profits from the previous decade.

But Credit Suisse’s latest woes were amplified by the recent fears following Silicon Valley Bank’s collapse, and its impact on the broader US banking sector.

Such contagion fears are then exacerbated when now one of the world’s crucial banks face fresh turmoil, so much so that Credit Suisse has now gotten a US$ 54 billion lifeline from the Swiss National Bank, Switzerland’s central bank, to stabilise matters.

 

How does this impact the ECB’s rate decision?

And as has often been said, major central banks keep hiking rates till “something” breaks.

Up until last week, many market watchers had believed that “something” would be the economy.

Given events involving banks on both sides of the Atlantic over the past week, that “something” is now apparently banks, which may have potential ramifications across the banking sector/financial system.

Keep in mind that a central bank is tasked with maintaining both the overall health of the financial system as well as keeping inflation from raging out of control.

Hence, the ECB may opt for a smaller-than-expected rate hike, if the previously presumed 50-bp hike could further break the banks.

 

On the other hand, the Eurozone still bears core inflation that’s at a record high (5.6% year-on-year in January). Up until last week, record high inflation has served as enough justification for the larger 50-bp hike.

Hence the ECB’s dilemma:

• Does the ECB put its battle against inflation front and centre, triggering a 50-bp hike, while risking further damage to its financial system that’s still raw and vulnerable?
   
• Or does the ECB opt for a 25-bps hike to preserve the still-fragile sentiment surrounding banks, but risk letting inflation rage further?

 

How does this affect the Euro?

Watch what the ECB does, and says, today.

For context, up until last week, here was the thinking surrounding the EUR’s typical reaction to ECB rate decisions: Higher interest rates tend to translate into Euro strength.

However, given today’s environment, a larger rate hike may ramp up recession risks for the Eurozone while further worsening confidence about the health of its financial system.

Such a narrative, stemming from a 50-bp hike, may trigger another risk-off wave and undermine the euro’s attempted rebound today.

Importantly, the bloc currency’s reaction today may have less to do with the size of today’s hike, but perhaps more about what the ECB says about the Credit Suisse situation.

If the ECB signals confidence that it can continue hiking rates, with the Credit Suisse crisis deemed to be transitory, that could spur more Euro gains; and vice versa.

 

Looking at the price charts …

EURUSD is trapped between several widely watched technical levels:

• 21-day simple moving average (SMA)
• 100-day SMA
• 38.2% Fibonacci level from its January 2021 – September 2022 downtrend

 

Potential Scenarios for EURUSD

1. A hawkish 25-bp hike by the ECB (meaning that the ECB still intends to keep hiking rates in the future despite opting for a smaller hike today) may be the risk-on catalyst for EURUSD to punch above its 21-day SMA and move closer to the 1.0690 resistance zone.
    
2. A dovish 25-bp hike by the ECB, with policymakers signalling concerns surrounding its economy/financial system, may potentially drag the world’s most-traded FX pair below its 100-day SMA.
    
3. Alternatively, a 50-bp hike may be seen as too much for now, and could prompt declines in EURUSD, especially if markets think that the ECB is only going to incur further damage on its banking sector even as it tries to uphold its inflation fighting credibility.

 

In short, EURUSD is perhaps likelier to react to market sentiment surrounding the Eurozone’s future health, rather than the fundamental actions of the ECB today.