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Fixed Income

Paying back the piper

View from the fixed income desk.

The effects of March’s mini banking ‘crisis’ seem largely done and dusted for markets. While it’s not productive to dwell on the past, there’s always something to learn from challenging situations. The main takeaway for me was how quickly the feeling of nervousness returned. The events of 2008 are not so long past that they’re forgotten.

Taking a more rational view, instead of signalling impending sector collapse, the fallen banks are illustrative of the fact that when interest rates are hiked so far and so fast there are going to be fallout effects. The piper had to be paid and banks were the currency.


Silicon Valley Bank, Signature Bank and Credit Suisse were not necessarily victims of mismanagement, but they certainly had problems with risk around their deposit bases. Their downfall is illustrative of the fact that banks more generally, have lent at lower rates (particularly on mortgages), and now their cost of funding has gone up, creating a mismatch. This is playing out first on weaker institutions or those that perhaps have larger loan books, particularly in property.

In turn, this is fuelling speculation regarding the possibility of the commercial real estate market being the next shoe to drop as some companies walk away from their obligations. But unlike in 2008, I don't think recent events in the banking sector are systemically important.

What they do highlight is that in the US (I think it's idiosyncratic to the US alone), you are going to see regional banks, which make up a larger proportion of lending for localised businesses, facing tighter credit conditions. I would expect to see a shift towards greater caution as a natural response to the current interest rate environment.

On sentiment, there’s some lingering nervousness, but volatility is lower than we’d expect at this point in the cycle. I think that's reflective of today's situation being unusual in that we still haven't seen any major pressures on the underlying economic environment that would suggest there is a big recession coming. Instead of recession, the market needs to get its head around the fact that inflation is going to be higher than the arbitrary 2% figure we’ve all got used to. And that's not necessarily a bad thing — you need a bit of inflation for an economy to grow.



From the monetary policy side, I think we’re almost done. We expect the US to follow through with its last one (or max two hikes), but the peak is in sight.

Historic patterns suggest that after a period of aggressive hikes (staircasing upward), you typically have a period of stability when central banks wait to see what happens, then rates drop very quickly (taking the elevator down). The market is expecting this pivot to kick in before the year is out, which seems unlikely to me.

“Staircase up, elevator down”: US Federal Reserve Fed funds rate over last 30yrs

Source: Bloomberg, Mirabaud Asset Management, data to 21 April 2023

In my view, inflation will take a little bit longer to come down, so the Federal Reserve (Fed) will likely hold rates until the end of the year and not cut as aggressively as investors are assuming. The caveat is markets remain very data dependent, so if the numbers start to tell a different story, then a quick re-think will be in order. History tells us that when rates begin to fall, they do so very quickly, but we would need to see definitive data on either a recession or much lower inflation for this trigger to be pulled.

For fixed income investors, vulnerability remains around the fact that the market continues to price in two US rate cuts by the end of the year when a pause at the top seems much more likely.


If employment begins to fall but inflation remains sticky, then we have a market scenario that’s a long way away from the 2023 pivot expectation that’s currently being priced. Underlying valuations need to adjust for a ‘higher-for-longer’ scenario, where the economy either slows or goes into a mild recession.

We continue to position ‘up in quality’, as we have been for the past few months, as well as reducing our cyclical exposure. A newer trade for us is reducing our consumer discretionary positioning because of its travel component. The underlying margin benefit of higher ticket prices and elevated demand for travel companies, particularly airlines, isn’t fully offsetting higher fuel prices, which is creating margin squeeze. This could be further exacerbated if we see a change in consumer behaviour and a reigning in of holiday spending as the cost-of-living crisis continues. Positioning reduction is underway across all our fixed income portfolios.


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