We’re all aware of the moves themselves, sure. But the metronome-like monthly increases from virtually every major central bank in increments that would have been unthinkable just a couple of years ago faded into the background. Those hikes – a huge 4.5 percentage points in a year for the US Federal Reserve, the global benchmark – were perhaps filed as simply a “symptom” of the inflation that simply refused to roll over as quickly as everyone had hoped.
With so much flying around markets, many investors didn’t have the time to think one step further to what the rapid increase in rates would cause . Many business executives didn’t either.
For a while, we felt that such rapid increases in the cost of financing must make something break. Exactly what it would be, we hadn’t the foggiest. We figured it would be an obscure hedge fund that had mushroomed into a problem in a dark corner of the market, hiccups with shadow banking operators, or problems in an arcane lending market.
We never thought it would be several US lenders – the 16 largest – including Silicon Valley Bank. Still less Credit Suisse, one of the 30 most important banks for global financial stability. It just goes to show that these things always pop up where you don’t expect.
In addition, we think both regulators and the banks themselves have done enough in recent weeks to bolster confidence in the finance sector and ensure that a financial crisis doesn’t develop. Banks are much better capitalised these days, and they haven’t loaded up on speculative loans to poor payers like they did 15 years ago.
However, it’s plain to us that this spate of bank failures is directly related to the speed and ferociousness of central bankers’ tightening – the value of their assets tumbled because of the rapid rise in prevailing interest rates.
Famously, it takes between one and two years for an interest rate movement to feed through to the households and businesses. After adding another 25-basis-point rise in March, the US Federal Reserve’s benchmark interest rate is now 5%. A year ago, rates were 1%, having been 0.25%, so we are still to truly feel the overwhelming majority of the hikes.
We think these banking blow-ups will inevitably mean tighter controls on bankers – and banks pre-emptively tightening their lending standards and rates – and therefore a reduction in lending to the wider economy. That increases the chances of a recession sometime this year, in our opinion.
There has been a lot of discussion in the UK about the number of households whose mortgages are set to roll over into significantly higher rates in the next year or two and the large effect it will have on their budgets. This will be a big headwind for the UK economy, but it is also a timely, simplified example for a similar phenomenon with a much greater importance for global investors.
After more than a decade of extraordinarily cheap debt, companies the world over are having to refinance at rates of interest many multiples higher.
This will be terminal for some businesses reliant on large amounts of borrowed money and razor-thin profit margins. Extra lending costs will quickly wipe out their profits and some may start haemorrhaging cash in coming years. This is why we’ve tried to be very careful about just how much debt the businesses we own carry and their ability to retain margins. Better to be a lender to solid companies in such a market than a shareholder in an overleveraged venture.
We are concerned that central banks have been raising rates way too fast and not waiting to assess how the effects were flowing through the economy. The single most important task for us in coming months is making sure our holdings can weather stress – whether a global recession, higher borrowing costs, or both.
David Coombs is head of multi-asset investments, Rathbones
