The problems at Credit Suisse may have precipitated concerns about the robustness of the wider banking sector, but there is little consensus on whether they have negative implications for the FX market in terms of either reduced liquidity or the short to medium-term trajectory of the euro.
Last week’s takeover of Credit Suisse by UBS followed months of upheaval within the former’s FX business. In late October 2022, it announced that FX and rates access would be closely aligned with the wealth management and Swiss bank franchises "to enable markets to reinforce its position as a solutions provider to third-party wealth managers."
A few weeks later it was reported that most of the staff in the bank’s FX voice trading business and FX sales team had been let go.
A number of senior staff have also left since the middle of last year. The Vice President eFX sales EMEA, Rory Barnes, went to (ironically) UBS as its new Director of FX Prime Brokerage Sales, while Ruchir Sharma, previously Credit Suisse's Head of APAC FX Trading, decamped to Deutsche Bank to take the role of Co-Head of global FX for Asia-Pacific.
There are a lot of conflicting narratives on the impact of last week’s events on interest rates. EUR/CHF is clearly an important currency pair for Europe and more importantly for Switzerland due to cross-border investments and trade.
“The question for bank treasurers will be what the impact would be of another rate hike on our liquidity forecasting,” said Julian Gladwin, the Co-Founder of Settlement Circle, which assists market participants in adhering to the FX Global Code. “On the other side will be how the ECB determines its policy to defend the value of the euro, knowing there could be a potential impact on the banking sector.”
There is probably a greater risk of contagion in the US from the Silicon Valley Bank fallout than in the eurozone from the Credit Suisse takeover according to Adam Gazzoli, the Co-Founder of FX consultancy The Adamis Principle.
“As such, it would seem more likely that the Fed might be inclined to pause rate hiking than the ECB, especially as the former is already further along in its hiking cycle and the ECB is still making hawkish statements, which could translate into a firmer euro versus the dollar,” he said.
Financial services industry consultant, Jason Keogh, does not believe Credit Suisse and wider banking concerns should change the ECB's stance on the basis that inflation is still by far the biggest fear of a central bank and the largest risk to any economy.
“However, we live in times where market forces can change the mind set and plans of the best of us and the ECB and others may feel pressured into backing down, which would be a disaster long term for the economy,” he said. “If the ECB changed its thinking it would create a short term boost for the euro, but have a detrimental effect in the medium to long term if inflation continues to increase and the central bank has to hike faster and harder in the future, causing a greater risk of a recession.”
FX Industry veteran Henry Wilkes, Head of Private Client Services at Oku Markets does not expect the ECB to change its thinking on interest rate rises as it was slower than most other central banks to start raising rates in the first place.
“If you look at market activity this week, the measures announced by the Bank of England and the ECB to shore up credibility in capital strength saw the dollar strengthen, but the euro managed to keep pace with it,” he said. “This is based on the market believing that the ECB may still tighten and therefore the spread between the Fed and ECB will be tighter than thought a few weeks ago.”
Richard Longmore, the Managing Director of FX consultancy Finoesis expects Credit Suisse’s problems to help catalyse thinking around the impact of QE's exit from the ECB.
“It will rightly be dismissed as a badly run bank, but a wider set of issues are hopefully being thought about,” he said. “The thought ‘if the Fed paused it would certainly help us retain credibility and not spark a ‘what do the ECB know’ moment if we don’t hike’ will be going through their mind.”
Longmore is sanguine about the impact on liquidity, suggesting that Credit Suisse is a bit part player that “used to be good in options, but the rest was a waste of time with the honourable exception of a few good emerging market FX traders.” This view is shared by Gazzoli, who reckons there are unlikely to be liquidity implications in the FX market given the scale of the overall support provided by the Swiss National Bank.
Many players have moved out of the FX market over the years and many new ones have entered, while the largest liquidity providers (banks) remain in the space. UBS will combine the two liquidity books and it could be argued that it will create a bigger player, which is better. That is the view of Keogh, who reckons liquidity is not the key issue here.
“The mismanagement of regulatory and risk rules is the greater risk in my opinion,” he said. “The only thing saving banks will do is allow future banks and their management to repeat the same mistakes, just like what happened after Lehman and Bear Stearns – which everyone said would never happen again.”
However, Gladwin takes a different view, suggesting that removing one of the largest two players in any market and creating a dominant player is likely to have an impact on both credit and capacity.
“Clients will not want concentration risk on the single largest player, which may not have the capacity to service the demand,” he said. “Both UBS and Credit Suisse have considerable CHF flows through CLS and both provide third party services to banks and asset managers. This requires a large intra-day credit commitment, or support by sight of underlying assets and cash flows.”
Each currency in CLS is supported by local currency liquidity facilities, one of which may disappear. The remaining Swiss banks may be challenged to service market demands as they may not have the product capabilities to take on such demanding FX settlement requirements.
“Currently there are no alternative FX settlement risk solutions available to meet potential demand and so credit risk constraints may ultimately impact on liquidity as a whole,” added Gladwin.
Wilkes also believes that the acquisition of Credit Suisse will have a major impact on liquidity in the CHF market. “The nature of the takeover will undoubtedly reduce the risk appetite in the newly created larger UBS and there are unlikely to be many medium sized banks willing to fill the liquidity hole,” he said. “Tighter market credit and risk conditions will keep the market nervous for the near future as the banking crisis continues to play out.”
Matteo Smolari, the Head of FX Risk Advisory at Audere Solutions says it would not be a surprise if UK banks came under scrutiny in the coming days and weeks, pressuring the pound lower.
With the latest inflation projections forecasting both core and headline inflation close to 2% in 2025, the ECB was able to hike rates but present the rise in borrowing costs in a dovish manner. The accompanying minutes shied away from hints towards further rate increases for the first time in several months.
“Needless to say, the fallout from Credit Suisse will linger for weeks and we expect investors to target European banks, limiting the ability of the single currency to rally,” said Smolari. “The dust needs to settle on Credit Suisse for a longer term direction on the euro, although we are positive that growth indicators from Europe should remain positive as the year continues, supporting the EUR and the ECB’s current policy stance.”
Historically during times of stability concerns in the banking sector, the Swiss franc would act as a safe haven. But, J.P. Morgan’s latest FX markets weekly report notes that as we saw in late September and October last year when other themes collided with widening CDS spreads on key domestic financial entities, the issue closer to home dominated the price action for the currency.
J.P. Morgan’s view is that should stresses in the Swiss financial sector avoid a systemic outcome, through liquidity facilities or loan programmes, CHF will be able to resume its conventional safe haven reaction function.
“CHF has traditionally been reliably anti-cyclical and does not have the yen’s current account deficit problem, but there is no historical template for how the franc might react when banking sector troubles centre on a Swiss institution,” noted the report authors.
