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Banking crisis: an example of uncertainties

The banking sector has seen several casualties in recent months - and there are probably more banks that will get into difficulty in the next few months.

| 6 min read

Although not a systemic issue, as the global banking system is well capitalised and regulators and central banks are taking swift action when issues emerge, it is a reminder that interest rates cannot rise so rapidly without having an impact on the global financial system. It also firmly underscores that no recovery is linear and shows that speedbumps can emerge rapidly and from leftfield.

Most significantly, UBS was coerced into buying its long-term rival Swiss bank Credit Suisse as confidence around this long-troubled bank waned, whilst in the US, some smaller banks are struggling as depositors seek more secure options. While this affects confidence - and if left unmanaged could become a cause for concern - we do nor believe this is a repeat of 2008

...it is unlikely we will see the US central bank cutting interest rates any time soon, as inflation remains a significant issue that needs to be dealt with concurrently.

Sharply rising interest rates in the US have hit the value of government bonds and for some banks caused mismatch issues between their lending book and asset book. Most of this problem has abated with recent bond market moves, easing some of the stress for other banks. It is, however, likely to limit sector valuations in the short term and cause some banks to rein in their lending activities to shore up their balance sheets. Perhaps the most significant market implication of all of this is for the Federal Reserve. It is likely that the US central bank will decide to lessen the pace of interest rate rises to help manage these issues. However, it is unlikely we will see the US central bank cutting interest rates any time soon, as inflation remains a significant issue that needs to be dealt with concurrently.

Market wobble

Global markets have rallied in the first weeks of this year on hopes that inflation may be easing, after the shock prompted by soaring energy prices. The FTSE 100 began to rally at the start of 2023, as investors welcomed China’s decision to relax Covid-19 restrictions, which was seen as a supporter of global growth.

Markets were heartened by the slide in US inflation, as well as the country’s strong employment figures. However, the hit to confidence caused by problems in the banking sector has been significant. Although, sector worries are now easing, so confidence is slowly returning on this front. US technology companies have rebounded substantially from lows at the end of last year, with the Nasdaq 100 entering a bull market in the last week of March.

Central banks cannot raise interest rates at the rate we have seen over the last year without some major implications. The global economy runs on money, so when the cost of money in the form of interest rates rise rapidly, growth may slow sharply or even give way to a recession. Recession fears have now eased as economic data remains robust, with much of this confidence due to falling energy prices. A relatively mild European winter and swift action to develop new liquified natural gas (LNG) infrastructure in countries such as Germany have helped with these fears. However, we have also seen a surprise on this front too. At the start of April, OPEC+ announced a surprise cut in production amounting to one million barrels per day.

The Saudi-led cut was likely influenced by the US announcement that the country was not going to buy oil to restock its strategic oil reserves, which have been drawn down over the last year following the energy price volatility we have seen as a result of the Ukraine war and sanctions on Russia. Although we do not believe that this will cause a reversal in the energy-price trend, it is an example of the new geopolitical tensions that have emerged between Washington and Riyadh.

Emerging market strains

Federal Reserve interest rate hikes also have global consequences, often forcing up rates in developing countries. The strengthening of the dollar can also be problematic for countries that have a significant amount of dollar-denominated debt.

After significant valuation falls because of a strong dollar and rising US interest rates in 2022, some now think we have seen the worst and that more bullish conditions will emerge. The dollar may not be as strong going forward as it has been in recent years, and it is likely that interest rates have now risen as far as they are likely to rise.

Emerging markets are often favoured by investors due to their growth potential, which is generally greater than that of more developed economies. However, that growth differential has been eroded. Growth needs to rise significantly higher in these economies than in the West to justify the risk involved in investing in these countries.

China’s sudden re-opening paves the way for a rapid rebound in activity but, despite recent optimism, data suggests its economy is still stuttering. Profits at Chinese industrial groups slumped 22.9% in January-February, according to official data. Optimism here is starting to wane.

Clearly, 2023 is shaping up to be a better year for investors and there is room for optimism on many fronts. However, recoveries have setbacks, well-laid plans must be altered due to events and – as the banking crisis shows – events can move rapidly and drag down confidence. These are the things we will be looking out for as the year progresses, as well as the significant growth opportunities presented by both the green and technological revolutions.

More from Patrick Farrell: Key market drivers for 2023

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Banking crisis: an example of uncertainties

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