The Dynamic Planner Investment Committee met on Thursday 27 April and reflected on the wider financial sector frailties following the fall-out of the Silicon Valley and First Republic Bank collapses in the US. In Europe, the dramatic loss of confidence in Credit Suisse led to a deposit run-off at digitally enabled speed and a wipe-out of its statutory capital reserves, held in specialist bonds called Contingent Convertibles or ‘Cocos’.
These events are symptomatic of the sharp increase in interest rates, shrinking central bank balance sheets and the receding tide of global liquidity that had flooded the financial system for much of the past decade. For those financial institutions that have relied too much on cheap liquidity, by taking on too much leverage and aggressively mismatching their balance sheets, times will be challenging given their magnified exposure to bond duration risk.
Should confidence in the banking system weaken further, this could result in contagion risks in other financial markets, particularly the leveraged pension funds. However, it was acknowledged that the major global banks are more robust than in the lead-up to the 2008 financial crisis, with global regulators requiring much greater capital and liquidity buffers. Despite the financial challenges faced from higher interest rates, growth has been more resilient than expected. Aided by a decline in energy prices, with a mild winter in the northern hemisphere helping reduce demand for natural gas, growth appears to have picked up in early 2023. Alongside the rapid reopening of the Chinese economy following the lifting of Covid restrictions, global growth has been more resilient than expected this year.
The IC also discussed the stickiness of underlying inflation being higher than expected at this stage of the economic cycle, indicating a broad-based ability for companies to both pass on higher input costs and maintain, or even expand, margins.
Read Q2 2023 analysis from Dynamic Planner’s Investment Committee.