The sharp increase in interest rates over the last
12 months has begun to cause some confidence issues
Following the disappointment of investment markets in 2022, 2023 has enjoyed a better start. Most of the major indices have bounced from depressed levels, driven by stronger economic data and the realisation we may be close to the end of this interest rate hiking cycle. However, the sharp increase in interest rates over the last 12 months has begun to cause some confidence issues, particularly amongst the smaller US regional banks as depositors took flight and investors locked into the higher yields from short dated US government bonds. The situation quickly escalated given the rise of social media alongside improved banking technology, allowing individuals to act much faster and withdraw their deposits shortly after the concerns were first raised.
However, the banking system, and the mainstream banking sector in particular, has come a long way over the last 15 years amid tighter regulation which has led to much improved liquidity requirements. For example, we note the large UK banks are secure, with Lloyds reporting £457bn of deposits at their Q4 2022 results.
Credit Suisse has endured some company specific issues for a number of years but the action taken with the bank (and with Silicon Valley Bank in the US) underlines that governments and central banks in contrast to 2008 now have both the tools available to shore up confidence and an understanding of the contagion risks in the banking sector. We do not believe we are on the edge of a banking crisis. By allowing the US banks to borrow against bonds held to maturity, increasing deposit insurance levels and providing liquidity, governments and central banks have done enough to contain the situation and likely are on standby should additional measures become necessary.
Going forward, the short term scarring from the episode is likely to lead to tighter credit conditions in the US. However, if this happens, we expect a more ‘dovish’ Fed and rate cuts later this year are a possibility, although we remain cautious about forecasting these for the moment, particularly if inflation does not fall as expected by the central banks.
The global economy has fared relatively well in recent months. The UK avoided a ‘technical’ recession with mild growth in the final quarter of 2022 despite the ongoing high levels of inflation. Expectations are now for GDP growth of 0.2% in the UK this year and 1.4% in 2024.
Despite ongoing high (but falling) inflation in the US in Q1 2023, several other economic indicators started to improve from depressed levels. Purchasing Manager Indices are often viewed as providing a reflection of how the economy is performing and these were a lot stronger than previous months, with the US economy starting to return to growth.
As well as this, the employment market remains robust, with low levels of unemployment still a key feature globally. Wage inflation however continues to be below inflation in the US and the UK. We believe a sharp decline in energy prices and a reopening of the Chinese economy are responsible for the improved global growth expectations. Similar patterns were noted in the UK, although inflation has remained high, increasing to 10.4% in March.
Interest rates have been increased again in most major economies. The Bank of England took interest rates to the highest level since the financial crisis at 4.25%. This was the eleventh consecutive hike and reflects the desire to fight inflation but recognising that the economy is currently still withstanding the pressures from inflation. The UK has clearly slowed down less than feared a few months ago and economic data continues to surprise to the upside compared to expectations.
It is this difference that drives equity markets rather than the actual level of growth. There are of course many risks from tighter lending standards, energy prices and interest rates. We continue to believe that many of these risks are factored into UK equity valuations and earnings forecasts. Therefore we continue with our bullish outlook for UK equities, which is reflected in our equity allocations. Ongoing takeover activity underlines our view that we have many excellent, globally focused companies in the UK trading at a discount to their global counterparts. Furthermore, despite the Credit Suisse event, a continuing improvement in investor sentiment bodes well for investment markets.
As ever, if you have any questions please get in touch on 0161 518 3500 or email a member of the team.
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