In light of recent events, we asked Ariel Bezalel and Harry Richards, investment managers for Jupiter’s global flexible bond strategy to comment on how turmoil in the banking sector has impacted the team’s thinking. Luca Evangelisti, Head of Credit Research, joined the discussion to provide specialist analysis: Luca is responsible for credit coverage on financials and is investment manager for our contingent capital strategy. This note was written on 16th March 2023.

In the 15 years since the Global Financial Crisis, regulators and policy makers have worked to establish macro-prudential and regulatory solutions to avoid a repeat. Yet banks are in trouble again. Is this the same old story?

There are many reasons behind recent issues with US banks and the contagion felt by Credit Suisse. The backdrop to all this is clearly the extremely sharp and rapid tightening in financial conditions over the last 12 months.

Rapid tightening raised the risk of accidents

We have been highlighting for some time now that rapid tightening in policy would create a risk of accidents. The first example was the UK Gilt crisis last year. A strong policy response helped to dodge the bullet in that situation, but it was clearly a sign that the system was under acute stress. We believe that recent developments on Silicon Valley Bank (SVB) and Credit Suisse have a similar root cause.



There were very specific structural areas of weakness in SVB’s business, such as high client concentration, mostly uninsured deposits, and unhedged interest rate exposure. When rumours started and investors began to pull deposits, the bank had to realise huge losses on its bond holdings and a vicious cycle started which ultimately caused the bank to fail.



We believe that European banks simply do not have the same issues and are in a much healthier state, but the pressure from higher rates still has the power to expose weaknesses – such as at Credit Suisse. For a long time we had limited our exposure to Credit Suisse across our range of fixed income portfolios. This was driven by elevated governance concerns, historical underperformance of their core operations and the difficult restructuring plan that lay ahead.



Credit Suisse is systemically important, but nevertheless when trust erodes, liquidity problems can quickly arise. For the moment it’s difficult to predict how these short -term bank issues will play out. What we can say is that central banks have learned from 2008, have a powerful toolkit, and have already stepped up in the US and Switzerland. 

A powerful warning signal
Considering the bigger picture, it’s clear to us that what’s going on in banking is a warning signal. The Federal Reserve (Fed) has tightened financial conditions at the fastest rate in history over the last 12 months, and these efforts take 12-18 months to fully impact the economy. Ultimately this is what they want to happen – to kill inflation – but history suggests central banks tend to go too hard, too fast, and the risk of further ‘accidents’, whether in banking or elsewhere, is high. This remains a global economy with $300 trillion of debt that is incredibly sensitive to higher rates in the long run.

It is our view that these banking issues will tighten financial conditions, because the transmission of credit to the economy will be impacted. Regional banks will be concerned about deposit flight as the kneejerk reaction from customers will be to pull out their money and instead save with the large, systemic banks – why take the risk of being involved in the next bank to fail?

Uncertainty around potential deposit flight may push these smaller banks to offer higher savings rates, reducing profitability and leading to more expensive lending down the line. Banks may be less willing to expand their balance sheets given the stress visible in the financial sector. Lending standards have already meaningfully tightened in the US and Europe, and the relationship with unemployment is clear. We believe that these developments materially increase the risk of a credit crunch scenario taking hold, which would be in keeping with our ‘hard landing’ thesis that we have discussed in many previous notes.
Lending standard surveys vs unemployment - Eurozone
Lending standard surveys vs unemployment - US

Source: Bloomberg, as at 31.01.23.

Inflation is still running hot on a monthly basis in the US, but base effects in our opinion will lead to lower year-over-year figures in the coming months. This should allow the Fed breathing space to pause. Slower lending would help to tame inflation and will eventually come through in the employment data. The shelter component of CPI that has been supporting core numbers in recent months will gradually revert back to trend as seen in real-time rental markets.

The positive news for bond investors from the last week has been a strong reinstatement of the negative correlation between developed markets government bond yields and credit spreads. If the macro backdrop continues to weaken, government bonds can provide diversification versus credit. If on the other hand the situation were to stabilize, with markets effectively “muddling through”, it remains a decent environment for carry, given the wider spreads.

At these levels, the all-in yield available across fixed income remains extremely attractive, in our view. As the effects of tightening continue to hit the economy and central banks consider the long-awaited pivot, the direction of travel in yields is to the downside, and further stress in banking or the wider economy can see yields lurch far lower. Overall, we believe a diversified fixed income allocation with exposure to high quality government bonds and to carefully selected corporate credit is a powerful tool for investors to navigate these uncertain waters with a controlled level of volatility and the potential for strong returns at the end of the journey.

The value of active minds: independent thinking


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