By Raffaele Prencipe,
Fixed Income Fund Manager


Central banks are fighting inflation by increasing interest rates. These increases deflate the value of assets: real estate, shares, and bonds. This can be problematic for leveraged entities.

The size of the world debt has increased exponentially in the last few decades. The global fixed income market has grown from 20% of world GDP in 1990 to a peak of 75% in 2020. Bank loans to households and corporates represent an additional 45% in the US or 80% in the Eurozone.

We have already seen some stress.

In September 2022, Gilt yields rose 1.5% higher due to the UK government’s large unfunded fiscal plan. The move was exacerbated as corporate pension funds were forced sellers of 30-year Gilts to meet collateral calls on their derivatives.

The Bank of England intervened with temporary purchases of long-dated Gilts.

Some emerging markets governments had debt restructuring and distressed exchanges. Gabon is the latest example.

Since March 2023, four US regional banks failed due to deposit runs. The FDIC intervened to protect all deposits, even the uninsured part >$250k. The government covered the FDIC’s $45bn outlay, which will eventually be repaid by bank deposit premiums and asset liquidations.

In Europe, authorities sweetened a deal to have UBS take over Credit Suisse after deposit withdrawals. Ad-hoc legislation prevented shareholder approval and allowed FINMA to wipe out CHF 16bn AT1s. The situation deteriorated after years of poor risk management: $5.5bn loss on Archegos; litigation provisions for its association with Greensill Capital, aiding tax evasion, and money laundering.

The real estate sector has also suffered. Asset managers temporarily limited withdrawals from property funds. In the US, office landlords defaulted on Commercial Mortgages. In Europe, Germany’s Adler and Sweden’s SBB are in crisis. In China, Country Garden missed interest payments.

Nevertheless, the economy has not fallen into a recession. Delinquency and default rates are increasing, but they are at historically low levels. Fiscal policy is still providing support. The US budget deficit, excluding the reversal of student debt relief, reached 7% of GDP in 2023. Payments on student debt haven’t yet restarted.

Will interest rates remain high for longer?

The answer depends on the cumulative impact on the economy. Though some of these emergencies were put out by extraordinary interventions by the authorities, consequences remain. For example, there is no growth in bank loans in the US and Europe. This is because banks have tightened lending standards, and because demand for loans is weak due to its higher cost, caused by restrictive monetary policy.

Source: DPAM 31.12.2022


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