27th March 2023 - Monday Espresso Podcast

[00:00:00] Sheldon MacDonald: It's the 27th of March today. Lots to speak about in the markets, although mostly focused on the fixed income and inflation and interest rate side of things, again. Let's kick off there. Obviously, last week when we were speaking, a lot of the focus was on what was going on with Credit Suisse. We've got Danny Fox, manager of the Marlborough Bond Fund on the line again.

[00:00:20] Sheldon MacDonald: Danny, some clarity there this week?

[00:00:22] Danny Fox: Yeah. We had the resolution to Credit Suisse with a takeover by UBS.

[00:00:26] Danny Fox: The way they structured it obviously called some question marks to be raised about the AT1 bank capital market, an announcement by the European and the UK authorities clarified the situation and made it clear that the Swiss treatment was unique way of treating those bonds and that the UK and European regulators would stick by the usual treatment by respecting the hierarchy, making sure that equity holders were wiped out before bond holders were hit.

[00:00:58] Danny Fox: That provided some stability in that market, at least for the start of last week. We then saw investors start to get nervous over some other names in the European banking sector, most notably Deutsche Bank, who suffered some quite severe share price falls into the backend of last week.

[00:01:18] Danny Fox: I think people were concerned that we were gonna see another weekend of developments in the banks over the course of the weekend. We've actually had a quiet weekend for a change of late and actually news coming out this morning that in the US where a further resolution to Silicon Valley Bank, where they've been taken over by First Citizens has provided a more positive tone this morning.

[00:01:42] Danny Fox: I guess the question is now, do markets continue to focus on the banking sector or do we return to looking at economic data, which we have some important numbers coming up towards the end of this week with the US PCE data.

[00:01:56] Sheldon MacDonald: Let's hold onto that for a second. We'll circle back to it. For the moment though, little fear of a systemic risk really indicated by markets. One thing that we look at is credit spreads and currently, credit spreads certainly below crisis levels and also really not rising steeply and so that would again indicate that you know, the credit market at least, isn't overly concerned with what's going on.

[00:02:19] Sheldon MacDonald: I guess the biggest impact that the, these episodes have had is on the expectations for interest rates going forward, Nathan?

[00:02:27] Nathan Sweeney: Yes, and interestingly, if you look at equity markets last week, despite all this news about the banking system fragility in the banking system, equity markets were up.

[00:02:36] Nathan Sweeney: So you wouldn't think that given all the news that's out there, but if you look at the UK market was up 1%, if you look at US stocks, they're up over 1.4% and the Chinese market was up 1.7%.

[00:02:49] Nathan Sweeney: So you're probably asking why is that and onto Sheldon's point, this is to do with expectations around interest rates.

[00:02:57] Nathan Sweeney: So if we look at central banks, they've been raising interest rates, now all of this uncertainty about what's happening in the banking system is causing investors to think that interest rates will start to fall from about the middle of this year, into the end of this year and that's why the market is getting excited about equities again, because ultimately it means the funding costs for equities will come down, or their profits will likely increase if they have lower costs from higher interest rates and as those interest rates come down, basically their profits will go up and the market is always forward looking as we know, and looking to get that priced in.

[00:03:33] Sheldon MacDonald: Markets forward looking, let's just look back for a second because during the past week we did see an upside inflation shock here in the UK, inflation surprising to the upside and that may have triggered, I guess, or or at least swayed the balance for the Bank of England in raising rates 25 basis points last week.

[00:03:52] Sheldon MacDonald: We also had the Fed raising rates 25 basis points and the ECB previously raising rates by about 50 basis points.

[00:04:00] Sheldon MacDonald: Going back to the point around the expectations for future rate hikes. On the US side, the Fed funds rate is the one we look at, futures had been pricing in an expected terminal rate at 5.5%. Those expectations got as low as three and a half percent during the course of the panic last week.

[00:04:21] Sheldon MacDonald: Currently though, pricing in at about 4% from the level of about 5% currently, so markets now expecting during the course of this year a 1% cut in interest rates, and that's certainly brought the expectations of cuts forward.

[00:04:36] Sheldon MacDonald: Let's look ahead to this week though, what are we looking forward to data wise?

[00:04:39] Nathan Sweeney: Well in the US specifically, we've got the inflation print, which Danny was talking about, so the PCE, this is the measure that the Fed likes to look at. If we see a continuation of a fall in inflation, then hopefully those rate cuts that the market is expecting will actually come to fruition.

[00:04:54] Sheldon MacDonald: As always, lots to look out for and we look forward to speaking to you again next week. Thank you.