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MARKETS

US stocks are trading higher Tuesday as investors look through another sticky inflation release and instead remain focused on VIX volatility and a welcome relief in Bank sector stocks, with the SPDR S&P Regional Banking ETF up 2 % (but off interday highs)

It certainly seems that inflation is taking a bit of a back seat for now, but the strong print could become more meaningful if financial stresses are resolved, and the market starts to focus on a longer Fed cycle. In that case, we could return to a higher rates regime and a stronger Dollar. 

After the recent global "financials" beatdown, it may take some time for the Fed and investors to become comfortable that the banking sector crisis has been sufficiently mitigated. Keeping in mind the speed of this cycle's volte-face and the accompanying velocity and quantum in the rates market moves these days will keep traders on their toes for days, if not weeks, to come.

Put another way, the ongoing events surrounding the US Banking sector continue to override other concerns. While most agree that more tightening will likely be needed to address the inflation problem if financial stability concerns diminish. But there is an excellent case to be made that Fed officials will worry that another interest rate hike could be counterproductive to efforts to shore up the financial system. 

Although short-dated maturity yields (2-year yields) were up 30 pips, they have now fallen back +16, suggesting the rates market agrees with that way of thinking, tightening will eventually be needed, but the Fed officials are likely to prioritize financial stability for now,

The Fed faces beyond-call optics, and I should emphasize there is nothing clear-cut right now. That is: every Wall Street shop has a differing but firm conviction about the events that have shaken the trees over the past few days. Indeed, this isn't simply a black-and-white answer; even if you think there is something categorically absurd not to hike in the face of too high inflation, would it not be even more bizarre to hike a fortnight after dousing the fires of systematic risk with QE, especially with smouldering embers dotting the landscape that could still re-ignite?

Unfortunately, Pandora's box has been opened; traders will still key on rates-sensitive parts of the economy. In recent months, we've seen a rise in commercial real estate (CRE) delinquencies, which we expect may be exacerbated by the volatility in the financial industry and greater lender scrutiny. Second to this are economy-driven industries, materials and energy, as the markets are sending one consistent message: fears of a US recession are imminent if you believe that pricing rate cuts rather than hikes foreshadow recession doom.

Competition for bank deposits is likely irreversible, leading to an upward trend in the bank-based cost of financing which adds an extra layer of tightening hitting the real economy. In any case, this will directly impact bank lending conditions amplifying the growth drag already underway. Put another way; it is not an excellent setup for oil traders. 

OIL

Oil markets are looking straight into that recession tunnel as energy traders draw a straight line to prior bank sector-driven recessions, especially the 2008 financial crisis, which has similar overtones to the current financial tumult and when oil tanked. In a mild OECD recession using playbooks based on the 2008 percentage drop, Brent oil could fall into the low $60 bbl zone( -$14-16 from current on a - 1 mbd drop in demand). Hence this is likely why the oil market is exhibiting recession jitters.

One way or another, global consumer confidence will take a significant hit, which usually squashes any upcoming travel plans that involve planes, trains and automobiles. 

Ultimately China's demand could hold the key to where oil prices stabilize; hence energy traders will be looking for China's data dump today to provide a lifeline. Unfotuanley for oil bulls, it still feels like a fader's delight.

GOLD

Even though gold would likely fare exceptionally well in a recession or broader bank stress scenarios, higher yields and mostly today's relative calm in the regional US bank sector should limit gold markets' topside ambition. 

G-10 FOREX

While expectations for Fed hiking have become significantly more uncertain, the EURUSD staying bid suggests traders expect the ECB will likely stay on the path at least this week. Euro look good, especially on the crosses, but could fire higher against the dollar if the Fed pauses.

ASIA FOREX

Market participants remain disappointed by the conservative growth target of "around 5%" and the lack of significant stimulus announced at the Two Sessions. And this will likely keep the traders cautious about the CNH and China's recovery, particularly given the slow pick up in the property sector and worsening geopolitical risk, at least until the data proves otherwise.  

Overall, we still think the downside for the US Dollar could be limited from here because any renewed banking crisis would trigger a sharp global risk-off benefitting the dollar due to its safe-haven status. If systemic risks fade and the focus shifts to the Fed's inflation fight, the dollar recovers much of its recent lost ground. Hence, we are trading long EURO big on the cross and not so much versus the USD straight up.

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