The banking issues experienced in March might lead to individuals and companies facing difficulties in obtaining finance. If this occurs, it could further dampen economic activity, alongside the impact of higher interest rates. Equity markets initially declined due to the banking issues but eventually recovered, ending the month positively. Bonds also gained.
The collapse of US banks Silicon Valley Bank and Signature Bank plus the required rescue / takeover of Credit Suisse by UBS thrust the issue of financial stability back into the spotlight for investors in March. Although the worst seems to have passed, risks remain.
These events are anticipated to result in tighter credit conditions, which, when combined with rising interest rates, could lead to a more significant economic slowdown or even recession.
Core Inflation Still Rising
Despite the relatively sharp decline in headline Euro inflation (orange line), core Euro inflation (yellow line) persists in its upward trajectory.
Interest Rates Rise Again
The banking issues presented a challenge for central banks deciding whether to raise interest rates in March. Ultimately, the Federal Reserve, European Central Bank, and Bank of England all opted to raise rates – Fed by 0.25% to 5%; ECB by 0.5% to 3.5% and Bank of England by 0.25% to 4.25%.
The rapid increase in interest rates may eventually cause problems for areas reliant on leverage, such as property.
Rapid rise in ECB interest rates over past nine months
We see vulnerabilities in the property market, particularly within commercial property. COVID-19 severely affected retail property, but its long-lasting impact on office space may prove even more significant as companies adopt new working models requiring less space. The combination of rising interest costs, reduced demand, and the need to upgrade offices to meet new environmental standards presents challenges for commercial property funds.
Additionally, higher interest rates are starting to impact residential property prices across Europe.
Other Notable Events in March:
EU Subsidies for Green Projects
As a counter measure to the US Inflation Reduction Act, which risks business moving some operations to the US, the EU published plans to enable countries to provide subsidies to companies investing in green technology.
€214bn Withdrawn from EU Bank Deposits
Banks have been slow to pass on higher rates to deposit holders. An article in the FT on the 27th March highlighted the fact that €214bn had been withdrawn from Eurozone banks over the past five months as people sought out better returns. Withdrawals also increased at the time of the banking issues as concerns about security of deposits increased.
Our Investment Outlook
Last month we said that the change in central bank policies from quantitative easing (QE) to Quantitative Tightening (QT) reduced market liquidity and increased the risk of market fractures. This month, we witnessed another market fracture – this time in the banking system.
- The impact of the banking fracture is to ultimately put further downward pressure on economic growth.
- That downward pressure, if it translates into a reduction in company earnings, may ultimately lead to an uptick in unemployment (the jobs market has remained incredibly resilient up to now).
- Central bankers likely need to be more data dependent going forward and see core inflation begin to fall it they are to avoid raising rates further. The risks of a policy mistake (by raising rates too far) have also increased.
- Ukraine and other geopolitical risks remain significant with bad outcomes not currently priced into markets. The core assumption of markets, at the moment, is that the Ukraine war will not end any time soon.
- Overall, markets are likely to remain volatile until there is more certainty around (a) financial stability (b) core inflation falling back to the target of 2% and (c) the depth and length of economic slowdowns / recessions.
For short-term investors, this is not a market to be in but for our clients who are long-term investors, we continue to advise them to follow their plan and use market weakness to build on positions.
John Tuohy is Chief Executive of Acuvest, an Irish-owned, independent advisory firm specialising in wealth management, pensions, and investment advisory services for individuals, companies, pension schemes, charities, and institutions. John is a Chartered Financial Analyst (CFA) and a Fellow of the Chartered Association of Certified Accountants.