End of the rate cycle is close

Oksana Patron

22 March 2023

With higher rates triggering a banking crisis, deposits risks and exposed risk management practices, the end of the rate cycle could be close and, if things get rally bad, the rates can be cut, according to AXA IM chief investment officer Chris Iggo.

He said that although higher interest rates in theory might have opened the door to deposit flight out of the banking system, this risk was overdone for the system, but left smaller banks more vulnerable.

At the same time, banks were put in a position in which they would need to raise interest rates on customer deposits which will then impact their net interest margin (NIM) and will be negative for earnings, adding to the already tight credit conditions.

Iggo said that the genesis of this crisis was an interest rate one, as opposed to the comparisons with 2008, as higher rates have exposed risk management practices where there were duration mismatches between assets and liabilities and any requirement to make good on the liabilities was going to result in realised losses.

“We must be open to the prospect of more evidence of financial instability and contagion risk. Now we are not in a systemic risk position – people are not taking deposits out of the system – but the cat is out of the bag on financial and corporate sector fragilities,” he said.

However, Iggo warned that according to the recent news the large US banks had to put some of their own  cash into deposits at another under-pressure bank and investors should be prepared to see more policy and industry-wide initiatives to support confidence.

So, what does the crisis mean for technology sector?

According to AXA IM’s CIO of core investments, the common denominator for US banks was their exposure to the technology sector which became problematic as the sector itself is already in recession.

Further to that, this would create a more difficult environment to raise venture capital for start-ups in artificial intelligence (AI), health technology and green tech and will put the large-cap listed tech companies with traditionally more cash in a position to take the advantage at some point of the early-stage companies, presenting an interesting theme to watch.

“Where does this all leave market views? I think it is hard to be bearish on rates now. We are surely close to the top of the cycle and financial risks have increased. Credit yields have not moved lower, so the short duration part of credit markets remains attractive in this heightened risk environment,” Iggo noted.

“For equities, the story hasn’t changed. Banks may see lower earnings, technology already has, and the energy sector is unlikely to match 2022’s performance with global energy prices lower. Any policy initiative to support confidence will be met with equity market rallies, but for the next few quarters the fundamentals look weak.”