Over the course of the first quarter, strong global economic and labour data ensured that the Federal Reserve, the European Central Bank and the Bank of England all maintained their restrictive policy, announcing two interest rate hikes each. However, despite this hawkish stance, the quarter saw both bonds and equities (as measured by the MSCI All Country World Index and the Global Corporate Bond Index respectively) eke out low, single digit gains.
Q1 2023 was not without volatility and market moving events. After data pointed towards a softening of prices in January markets, both fixed income and equity started the year strongly in the hope that the end of the tightening cycle was in sight. However, surprisingly strong growth and labour data in February (with the falling of natural gas prices helping Europe, and re-opening of China post-COVID providing a boost) put aside any hope that central banks were done with their tightening. The strong labour market pointed to unemployment rates moving below their pre-pandemic levels for many of the world economies. As a result, the broad message that price pressures remain too high continues to be the core focus at all three of these central banks. The market had to reassess where rates would peak and push back any hope that rates may be cut on the back of a recession.
Strong economic data was not restricted to just the Western economies. China’s re-opening post the abandonment of their ‘zero-COVID policy’ resulted in a strong pick-up in activity, helping not only the domestic economy, but also boosting growth in Europe and Asia. However, geopolitical tensions between China and the West continue to impact investor sentiment in the region.
It would be naïve of us to think that one of the fastest and most aggressive rate hiking cycles in history would not result in some ‘casualties’. Whilst we saw a dramatic fall in the prices of all cryptocurrencies, the big news event of the first quarter came in March when the collapse of Silicon Valley Bank (SVB) highlighted the problems and dangers of aggressive rate hikes. Whilst the problems at SVB were unlike those witnessed during the banking crisis of 2007/08, there were concerns surrounding contagion. Fortunately, swift central bank action across the developed markets ensured the problem was contained, with all deposit holders being guaranteed access to their money.
SVB was not the only high-profile banking failure during March – we also saw the collapse of the 167-year-old Swiss Banking giant Credit Suisse. Their problems have been well flagged for a few years. Once again, the Swiss National Bank was quick to take action and calm markets by ‘orchestrating’ a takeover of Credit Suisse by UBS. However, this came at the expense of subordinated bondholders who were wiped out in the process.
Looking forward, the recent woes in the banking sector will leave central banks with a tough decision on their pace of rate rises. There is every reason to believe that banks will now impose tighter capital conditions, which may equate to a further percentage point of rate hikes as lending standards are increased. As a result, we may be coming to the end of this tightening cycle, with maybe one more rate rise in May before we see a pause by central banks.
Whilst every cycle is different, and this one more so because of the pandemic, we do, as in previous cycles, expect to see the impact of higher rates in coming quarters. The ‘lag’ can at times be long and, with some 14 months since the first-rate hike, we expect economic activity and pricing pressures to abate towards the end of this year.
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