Multi-Manager People’s Perspectives

The US banking regulator, the Federal Deposit Insurance Corporation (FDIC), said that regional bank liquidity remained stable, while the new Bank Term Funding Program set up by the Federal Reserve appears to be helping US banks manage their balance sheets. There was a brief storm around Deutsche Bank, whose credit default swaps spiked, but the reality is that Deutsche has strengthened its position significantly in recent years having undergone the restructuring that Credit Suisse tried, and failed, to achieve.

The underlying issue of higher interest rates causing stresses in the financial system remains, of course, and central banks clearly have a policy dilemma:  rates in some countries appear not to be high enough to bring inflation back down to targets – but are already high enough to be causing “accidents”. Slowing economic growth resulting from 12 months of rate hikes, along with base effects, will bring inflation lower as the year progresses. However, central bankers remain concerned over the persistence of inflation in the food and service sectors, even as manufacturing and energy prices have rolled over.

Bank of England (BoE) Chief Economist, Huw Pill, said earlier this week that “persistent deviations of inflation from target, even if stemming from what are fundamentally a series of transitory inflation shocks, might prompt changes in behaviour that generate more long-lasting inflationary dynamics”. Market expectations on the path of interest rates continue to see significant shifts as economic data and central banker’s speeches are digested, but if calm continues in the banking sector the door remains open for banks to hike as they feel is necessary to ensure the inflation genie is put firmly back into the bottle.

Central banks are convinced this is not a repeat of 2008, with the systemically important banks in far better financial shape. BoE Governor, Andrew Bailey, told the UK Treasury Select Committee that the market turmoil was “very different” to the global financial crisis but said the Bank was “in a period of heightened alertness” and that “creditor hierarchy in the UK is a cardinal principle”. That final quote is a nod to bond markets unsettled by the decision of the Swiss authorities to wipe out certain bondholders when Credit Suisse was rescued. Both the Bank of England and the European Central Bank (ECB) have made clear they would not follow the same path should a repeat of Credit Suisse occur in a UK or eurozone-based bank. The ECB’s Chief Economist, Philip Lane, said he expects the financial sector to “settle down” and rather than rate cuts, “more hikes will be needed”.

Rising oil prices will have caught the attention of the central banks after OPEC+ agreed last weekend to cut production by just over 1 million barrels a day, with the bulk of the cut coming from Saudi Arabia. Since my last update oil has climbed 12%, with a barrel of Brent Crude now at $85 – albeit still a long way from the levels of last year. OPEC+ represents 40% of global oil output, but despite the move higher in the oil price there appears to be little concern as demand for oil is expected to slow as western economies slow. How much of this is offset by higher demand as China recovers is a big unknown.

The economic data has been dominated by the usual start-of-month PMI data. The ongoing theme of manufacturing weakness but stronger services persisted across western economies. Japan saw notable strength in the services sector, with the highest PMI print for almost a decade. China also saw strong services and manufacturing PMI data as its economy shakes off the shackles of the zero-Covid period. The eurozone saw evidence of easing inflation, with CPI at 6.9% year-on-year in March, lower than expected and well below the 8.5% reported in February. PPI data for the eurozone was also encouraging as a lead indicator for inflation: while a rate of 13.2% year-on-year in February remains high historically, this was the sixth consecutive month that PPI has eased, down from a peak of 43.5% in August 2022.

So where do we go from here? We’ll cover our outlook in the webinar next Thursday (see below to register), but overall we remain cautious in our positioning in the belief that while the systemic risks from the major wobbles in the financial sector remain in check, there will be consequences in terms of tighter credit conditions. This, along with the lagged impact of rate hikes now being felt, will slow economic growth. While we’ve avoided the worst-case scenario that we would have seen had energy prices remained painfully high, we do still see negative consequences as the aggressive rate hikes of the past year, with possibly more to come, work their way through the system.