There is no way around a stronger Dollar

Fears of systemic risk in the banking sector

Lately, fears of systemic risks in the banking sector has been the most prominent and important market theme. The collapse of the regional US Silicon Valley Bank (SVB) on 10 March triggered stress in markets with yields plummeting and volatility spiking. As a result, the Fed promptly set up an emergency program to avoid contagion to the broader US financial system. Nonetheless, concerns have still spread to European banks with most recently the Credit Suisse Group coming under pressure leading to an acquisition by the UBS. European bank stocks have heavily underperformed benchmark indices. Despite a broad repricing lower of major central banks' rate outlooks, the ECB stood its course raising all policy rates by 50bp at the March meeting. Overall, recent events highlight the rising trade-off facing central banks amid the need for a contractionary policy to bring inflation down and the risk of breaking something systemically important.

We are cautiously optimistic on subsiding systemic risk fears

Rising systemic risk fears have unsurprisingly led to higher FX volatility. In majors space, JPY and GBP have benefited while cyclical sensitive currencies have faced headwinds. USD has fluctuated wildly in tandem with US specific news, risk appetite and relative rates moves. After a temporary February rebound, both SEK and NOK have come under renewed pressure. Lower energy prices have market a hit to the notoriously risk appetite sensitive NOK but also SEK has suffered in recent weeks despite the Riksbank's renewed focus on imported inflation and hence currency weakness. Also the growth outlook and housing markets remain SEK headwinds.

In our base case, we are cautiously optimistic on systemic risk fears subsiding although we acknowledge that the outcome space is very wide. We maintain our strategic case for a lower EUR/USD and thus keep our downward sloping profile forecasting EUR/USD at 1.02 in 6-12M. We continue to expect the SEK to struggle over the medium-term horizon on the back of a relatively worse outlook for the Swedish economy compared to peers, valuation as well as an increased risk of overtightening by the Riksbank. In NOK, we acknowledge that the near-term prospects for NOK look more challenging than previously pencilled in and lift the short-end of our forecast profile, but keep the downward trajectory.

At present, the key risk is a more widespread crisis in the banking sector, which would create substantial downward pressure on inflation and growth prospects. A key assumption behind our FX forecasts is that of a stronger USD and tightening of global financial conditions. Risks to this assumption primarily lies in Fed delivering an actual policy pivot - possibly due to systemic risk fears or a weaker US economy than we expect.

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