Important US inflation data Tuesday.

The US move to protect all deposits at Silicon Valley Bank (SVB) and potential risk of contagion in the financial sector continued to dominate during Monday. Conditions were slightly calmer on Tuesday, although there were still notable nervousness.

Unease over the US financial sector triggered a further shift in expectations surrounding Federal Reserve policy. For the March policy meeting, markets moved to price out completely the possibility of a 50 basis point hike.

Indeed, markets signalled close to a 30% chance that there would be no increase in rates from 4.75% and at least one bank forecast that there would be a rate cut.

There was also a shift in ECB expectations with markets now considering that the most likely outcome is that there will be a 25 basis-point rate hike compared with 100% expectations of a 50 basis-point hike last week.

The New York Federal Reserve 1-year inflation expectations index dipped to 4.2% from 5.5% previously and the lowest reading since May 2021.

The 5-year index increased marginally to 2.6% from 2.5%. Over the weekend, the US Treasury and Federal Reserve announced that all deposits in SVB would be protected. The move triggered a strong rebound in risk appetite with a recovery in equities.

The US 2-year yield slumped on Monday and hit 4.00% for the first time in close to 6 months and compared with 5.00% last week. The 2-year yield traded just below 4.00% on Tuesday.

The slide in bond yields, unwinding of yield-curve inversion shift in Fed expectations and a rebound in risk appetite triggered sharp dollar losses.

The dollar index overall dipped to 3-week lows on Monday before a tentative recovery on Tuesday.

The UK labour-market data recorded an unchanged unemployment rate of 3.7%. The headline increase in average earnings slowed to 5.7% from 6.0% with underlying increase at 6.5% from 6.7%.

The US consumer prices data will be released on Tuesday. Consensus forecasts are for  a 0.4% increase in prices for the month with the year-on-year inflation rate declining to 6.0% from 6.4%.

The core annual rate is forecast to edge lower to 5.5% from 5.6%.

The Fed will find it easier to justify backing away from a March rate hike if the data is in line or weaker than expected while strong data would cause major tensions. Given the financial-sector focus, the impact may be less than expected otherwise.

The dollar was hurt by a further sharp slide in 2-year yields on Monday. There was also a sharp drop in Euro-Zone yields which limited the impact to some extent. Overall risk appetite was fragile, but the dollar was unable to significant secure defensive support. EUR/USD posted highs near 1.0750 before a retreat to near 1.0700 on Tuesday.

Lower US yields were important in driving the yen stronger. The yen also gained ground when Wall Street equities dipped lower. USD/JPY dipped sharply to lows at 132.30 before a recovery to above 133.00. USD/JPY briefly hit 134.00 on Tuesday before fresh losses to 133.20.

Weaker financial risk sentiment triggered renewed Swiss franc demand. EUR/CHF dipped to 4-month lows below 0.9720 before a recovery to 0.9775. USD/CHF posted 5-week losses near 0.9070 before settling just above 0.9100.

Sterling was resilient despite weaker risk appetite. Federal Reserve and ECB rate expectations dipped more sharply than for the Bank of England which provided some support. There was also some evidence of underlying short covering. Labour-market data limited scope for further support. GBP/USD posted strong gains to highs near 1.2200 and settled around 1.2170 on Tuesday.

Commodity currencies benefitted from the Fed re-pricing and a weaker dollar. AUD/USD surged to highs above 0.6700 before a retreat to 0.6670 and traded around 0.6660 on Tuesday. USD/CAD dipped to 1.3680 before a recovery to 1.3720.

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