Neil Birrell, Premier Miton’s Chief Investment Officer and manager of the Premier Miton Diversified Fund range, discusses the risks being posed by the banking sector that are making the headlines.
For information purposes only. Any views and opinions expressed here are those of the author at the time of writing and can change; they may not represent the views of Premier Miton and should not be taken as statements of fact, nor should they be relied upon for making investment decisions
Investing involves risk. The value of an investment can go down as well as up which means that you could get back less than you originally invested when you come to sell your investment. The value of your investment might not keep up with any rise in the cost of living.
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Never a truer word
The final section of this note in February was;
“I have deliberately kept this note shorter than usual. Mainly because I have little doubt something noteworthy will crop up soon that requires comment.”
Well, I was intending to write this note next week after the meeting of the US Federal Reserve Bank (Fed) and the announcement of the change to interest rates. We would also have heard from the European Central Bank (ECB) and the Bank of England (BoE).
I thought we might have got to a stage where the balancing act between beating inflation and avoiding recession was the main story and it was moving towards an ending. Then we get hit by a “banking crisis”. Or is it?
Is this 2008 in the US all over again?
Speaking to our US and banking sector specialist fund managers has given me considerable comfort over the wider risks potentially created by the collapse of Silicon Valley Bank in the US. It was a very specific, although sizable, bank that mainly made loans to technology and venture capital businesses. This is high risk lending and the bank had poor risk controls and loan book management in place which came home to roost.
However, the immediate reaction was to fear that the problem is more widespread than localised. Yes, there will be bad lending decisions and losses within all banks, but it does not look like this a problem that is more general, even though the share prices of a number of related regional US banks collapsed as a result.
Credit Suisse
This is a somewhat different and considerably larger issue.
Firstly, Credit Suisse has been on the radar for some time as being in a poor financial position and it is not surprising that this is getting reflected in the prices of bonds and shares issued by the company and also in other financial instruments related to the bank.
Given the risks that the failure of Credit Suisse would bring to the global financial system, regulators and other authorities will be heavily involved in the situation. Indeed, the news that the Swiss National Bank had provided 50 billion Swiss Francs ($54 billion) to the bank has calmed nerves.
The short term for Credit Suisse will remain fraught and a long-term solution needs to be found, but I think we can relax a little for now, although the situation is far from over for Credit Suisse, US regional banks or the financial system overall.
“They will keep going until something breaks”.
This has been a line that has been used to describe the approach that central banks will apply to their interest rate policy, particularly relating to the Fed. Maybe something has now broken, and they now have another problem?
Interest rates were rising to beat inflation. The central banks were of the view that embedded, high inflation was a greater risk than recession, which might be the result of interest rates being higher for longer. But higher rates are less good for financial markets. The battle lines were drawn; central banks vs. “the markets”. When this happens, the markets usually win, but that did not seem the case this time around.
However, the central banks now need to deal with the additional risk of putting interest rates up further and causing more stress in the financial system. In the immediate aftermath of the bank issues described above, the expectations of what policy would be adopted changed at a speed and scale that I don’t think I have seen before. It went from fairly significant further increases to no more increases and, in fact, a fall in interest rates in the short term.
To put some context on that, the target interest rate in the US is currently 4.75%. During the last few weeks, it was expected that it would be put up to 5.50% at a peak in the middle of this year. In the last week, expectations changed to; no more increases and significant reductions through the rest of this year.
This is the battle between the Fed and markets.
Specifically, at the Fed meeting on 22 March the anticipated increase went from 0.5%, as the Fed had been indicating, to 0.0%.
If I were a gambler, and I’m not, I’m an investor, I’d suggest we will see an increase of 0.25% and comments from the Fed that they are conscious of the bigger picture and financial stress; thus showing that the need to beat inflation remains but they are sensitive to other factors.
Thanks for that, but what should I do with my investments?
I am not qualified to give financial advice, but I do think, as I have for some time, that caution is appropriate and that has been heightened by events over the last 10 days. We are at or near a critical point in the economic cycle when stress in the system is high.
But this is all known. As ever, it is the unknown that is the likely problem. For now, those unknows that have come to light appear to be containable, although they have caused significant volatility and remain a concern.
It is important to focus on the long term and remember that volatility in the short term can provide very interesting opportunities for active investors.
The last word
There are important announcements from the European Central Bank and Bank of England as well, but they are a side show. The main act is the Fed.
Finally, the Chancellor’s spring statement was interesting. It was a plan for growth that was nothing like the one in autumn’s mini-budget, thankfully, but did not contain anything to distract us from the bigger global picture.
I will provide an update after the Fed’s decision is announced on 22 March, by when, hopefully we will have more clarity on the “banking crisis”, which could disappear as fast as it arrived.
