The economy is improving, but financial risks are a concern
At first glance, this data seems to support central banks in their decision to continue raising interest rates despite increased banking risks. However, investors fear that monetary policy restrictions have already reached an unsustainable level for the financial system and, by extension, for the economy. The credit crunch, falling real estate prices, bank failures and the fragility of other players in the financial system, such as commercial real estate, may well cause a downturn sharp enough to trigger a recession. This scenario is already partially incorporated within market prices, particularly in the United States, where monetary rates are now expected to drop by more than 100 basis points in the second half of the year.
On the other hand, for central banks, the tightening of the credit channel simply proves that their policies are working, bringing them closer to the end of the rate hike process. The decline in certain inflationary pressures, including energy prices (cf. chart 2), also supports their objectives of reducing inflation. Moreover, advances made in prudential regulation since 2008 have encouraged central banks to believe that a radical change in monetary strategy will not be necessary to save the financial system. Finally, central bankers have already made it known that they would rather to do too much than too little in the face of persistently high inflation.
Market volatility is also being fuelled by the banking system’s dependence on political intervention. For example, some statements given by Janet Yellen have raised doubts (which are hoped to be unjustified) about the vital principle of guaranteeing bank deposits. Similarly, the Swiss government’s involvement in the rescue of Credit Suisse has led some observers to think that the logical hierarchy of losses has not been respected.
All of this justifies a certain level of caution. However, it must be noted that financial markets have already undergone significant adjustments since 2021, first by the devaluation of assets that had most benefited from Covid (Nasdaq, Chinese securities, government bonds), then by the appearance of risk premiums linked to the war in Ukraine, inflation and the sharp rise of the dollar. The PER for global equities has therefore already been significantly corrected without plummeting (cf. chart 3). Moreover, a significant economic slowdown would cause the expected decline in inflation to speed up, limiting long-term interest rates and restoring purchasing power. Provided that the financial risks remain minimal, all this should be able to limit the negative impact of the slowdown in sectors most sensitive to the credit channel.
In our global funds, we are adapting our strategy to this new environment. We are reducing the weight of the core basket of international equities (200 securities) to allow us to be more agile. We are also reducing our exposure to the rather cyclical theme of the energy transition.