Central banks have spent the last year or so pushing interest rates higher at their fastest pace for decades in the face of an inflation shock. Cracks were exposed in several large US regional banks which saw regulators step in to protect depositors amidst a flight of both confidence and cash. This sparked a wave of negativity toward the banking sector, spilling over to Europe, where confidence evaporated in the multi-year turnaround story at Credit Suisse and a regulator-backed takeover by its rival, UBS resulted.
UK consumer confidence is low but coming off its previous very low ebb. In what feels like a period of never ending cost-pressures and high inflation, retail sales have grown during the first months of the year and whilst the refinancing of debt into a higher interest rate environment will be a headwind for those with loans and mortgages, offsetting this are households who, in aggregate, albeit unequally, are still saving more than pre-pandemic, in an economy supporting workers with plentiful jobs and unemployment at 50 year lows.
US consumers have been happier to spend down savings and events that have seen some large regional banks become insolvent, could dampen bank lending more broadly impacting consumers ability to keep on spending on finance. The ferocious collapse in ‘real’ earnings growth will also begin to suppress demand. Lower growth and falling inflation are the order of the day, but inflation isn’t done with us yet.
Central banks have a trickier task in the wake of banking failures. There remains the pressing problem of inflation, but so is there the reluctance to see banking failures become even more of an issue. Central banks have plenty of tools to deal with the matters separately, containing the bank risks with support packages, mergers and liquidity, whilst using interest rates to combat inflation. These twin aims are not mutually exclusive and will likely result in lower peaks in interest rates than markets were anticipating just a few weeks ago. We are fast running into a period of falling inflation and less aggressive central bank policy, which are ultimately favourable backdrops for the long-term investor faced with more attractive asset class valuations than we’ve seen for some years. In the near term though, headwinds from this crisis in confidence remain.
In fixed income markets, 2023 has seen a marked shift from 2022. Bond yields have moved lower (& prices risen), reinstating their diversification benefits in portfolios. We continue to use several strategic bond funds, some of which have been slowly increasing interest rate sensitivity in portfolios, in anticipation of falling interest rates. The yield available from fixed income, whether it be government of corporate bonds also serves as a positive, long-term backdrop.
The mood in equity markets remains skittish, particularly in relation to bank stocks, but valuations still look attractive after a miserable 2022. This makes prospective long-term returns from equities look more positive than they have been for some time. Areas such as US equities have seen valuations move from ‘expensive’ to ‘average’. Others, particularly the UK and Japan are looking cheap versus history, but both require a catalyst to unlock that value. Pressure on corporate earnings and profits will grow as consumer spending pressures build.
Sterling strengthened against the other major currencies. Brent Crude started the year just below $86/barrel but moved lower by the end of March to $79/barrel. Gold rose sharply towards $2000/oz as concerns rose about the banking sector, but drifted lower to close at $1969/oz.