Good morning,
1. How sticky or not sticky is inflation?
The big economic story clearly continues to be inflation and may be for some time. At the beginning of the quarter markets were perhaps overly optimistic about how quick they expected inflation to fall. However, that optimism quickly dissipated in February as the view turned to inflation being more ‘sticky’. In essence, markets believe inflation has peaked and will continue to fall, but the questions now are – how quickly will it fall, and will it get stuck on the way back down? These are quite literally billion-dollar questions that the market, and central bankers for that matter, will continue to try to wrap their heads around. In the meantime, the levels of inflation have continued to be high enough for central banks to justify the continued increase in interest rates. Interest rates have been rising globally, however, if we focus on the ECB, we’ve seen an increase of 2.5% to 3.5% this quarter. Not forgetting that it was only last July that interest rates were only 0.0%. This has been a huge and quick increase, which helps to contextualise the market turbulence we’ve seen of late.
2. The mini banking crisis seems to have been calmed and contained
The mini banking crisis which led to the demise of Silicon Valley Bank (SVB), a US tech lender, and Credit Suisse took centre stage in March. On the face of it SVB and Credit Suisse have very little in common, given the difference in client type, assets and even location. However, the combination of higher interest rates coupled with a loss in investor confidence, caused a liquidity problem (in other words the banks no longer had enough cash to continue to operate). Events like this make banks less inclined to lend to one another, which is problematic for the wider economy. However, central banks and regulators promptly stepped in to calm the situation. Our base case is that there is no system-wide problem; in fact, as at the end of the quarter things already seem to have settled down with markets obsessing over inflation once again. Nevertheless, this is a timely reminder that banks can be irresponsibly run and that higher interest rates hurt and ultimately expose areas of weakness and vulnerability.
3. The markets have been surprisingly resilient, despite everything that’s been thrown at it
Despite high inflation, higher interest rates and the mini banking crisis you may be surprised to know that equity and bond markets have delivered decent returns so far this year. But that’s not to say it’s been a smooth ride; quite the opposite. The year started with equity and bond markets performing very strongly, but from February onwards market performance became somewhat mixed and volatile. This was especially true for fixed income markets, which grappled with inflation on the one hand, which pulls the value of fixed income markets down, versus the mini banking crisis, which pushes the value of fixed income markets up as investors seek ‘safe havens’ to squirrel their money away. World Equity markets finished the first quarter up 5.5% while global sovereign and corporate bonds were also in positive territory up ca. 2.5% during the quarter.