What is undoubtful is that tomorrow’s rate announcement will be a big risk event, and markets are only pricing in a 60% chance of a hike. On the flip side, a hold may either reassure investors or be interpreted as a de-facto sign of alarm. A 25bp move, which is still narrowly our base case, can either be read as a sign of confidence in the financial sector and a reiteration of the inflation focus – remember the Fed already deployed a funding facility and boosted USD swap line to ease financial stress - or as a policy misjudgement that could accelerate banking troubles. This is a similar kind of conundrum to that faced by the FOMC as it starts its two-day meeting today. The market impact of such emergency measures has not proven to be unilateral during the ongoing banking crisis, as officials are often walking a very thin line between offering a backstop against systemic risk and risking an exacerbation of the ongoing banking turmoil by sending the “wrong message” of mistrust in the banking system. The core of the issue is whether the Treasury ultimately holds the authority to expand that insurance without the approval of Congress. The Treasury is reportedly seeking legal paths to expand the FDIC insurance to all deposits greater than $250,000 following requests by multiple banks concerned about contagion risks and further deposit outflows. In the US, the regional bank turmoil remains far from resolved. European regulators and central bankers are now attempting to restore confidence in the AT1 bond market, which now poses a major threat to any extension of the recovery in investor sentiment in the region. The market’s focus in Europe appears to be on the vulnerability of Additional Tier 1 bondholders after the Credit Suisse acquisition deal by UBS saw AT1 bonds being wiped out. Today’s session will really be a test of the sustainability of yesterday’s rebound in risk sentiment and pro-cyclical European currencies.
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