Banks are not out of the woods yet with a financial crisis still on the cards, according to Keith Wade, chief economist and strategist at Schroders.
Fears following the collapse of Silicon Valley Bank (SVB) and takeover of Credit Suisse may have largely passed but Wade said that “we should be wary of treating recent bank failures as isolated incidents”.
There were several factors at play in the downfall of these banks but a tight monetary environment had a significant role to play in their difficulties.
Wade said: “Although the problems in the banking sector have idiosyncratic causes, they are also a symptom of monetary tightening impacting the economy. They are a classic sign that policy is biting.”
The Federal Reserve (Fed) noted this sensitivity and raised interest rates less aggressively in March, increasing by 25 basis points from the 50 basis point projection.
However, the central bank could be pushing its luck if it returns to more hawkish hikes at the next meeting in May, according to Wade.
“Markets have stabilised since then and fears of a credit crunch have receded,” he said. “Alongside the continuing tight labour market, this might encourage the Fed to revert to a more aggressive tightening path.
“Despite more benign financial conditions, the actual bank lending numbers are weak with loans to business, real estate and consumers all decelerating sharply over the past three months.”
William Davies, global chief investment officer at Columbia Threadneedle, agreed that the speed at which the Fed has increased rates has been challenging for markets.
The central bank hiked rates from less than 1% to 4.75%-5% within a year, creating a starkly different environment from the loose monetary conditions of the past decade.
Davies said: “Whenever a change occurs as quickly as that there is going to be a fallout and that's what we've seen over the past month.
“The thing we've got to be careful of when you get a cost of capital that changes so quickly is to make sure you are investing in companies able to cope with that.”
Indeed, Davies was closely monitoring the market for instances where one failing company had a “contagious” effect on the rest of its sector, which could result in a crisis.
He said: “Is that change in consumer spending something that then persists, or is it just cyclical? To my mind, it's more cyclical in that respect but we have got to be careful about particular sectors that are being impacted.”
Even so, Davies said that the current financial sector is “absolutely not” like the conditions during the global financial crisis of 2008 as many have feared.
Back then, the vast number of subprime loans were “endemic across the whole financial system,” whereas recent collapses were driven by the situations at individual firms.
For example, Davies pointed out that SVB was brought down by a wave of deposit outflows while those at most major banks have remained stable.
He said: “Corporates are pretty well capitalised so we would expect that to lead to a slow down and a mild recession rather than a financial crisis.”
Nevertheless, Davies noted that unforeseen movements in the market can swiftly turn an otherwise stable sector on its head.
“I would never be so arrogant as to say that we know where all the risks are – that would be foolish,” he said.
“Within the banking sector, there has been work done by regulators to help build those capital buffers but that didn't change the fact that SVB went under, which is why I would not say we are confident that we know where all of those risks may be.”
Banks could undergo continued pressure for at least the rest of the year if the Fed does not lower rates.
When the Fed reaches the peak of its rate cycle, Davies forecasts that they will remain at this high level until 2024.
He said: “We’re looking up until 31 January, which is probably overly optimistic in terms of the rate reductions that we'll see moving forward.”
This was echoed by Wade, who said that a tight labour market could keep inflation high and prevent the Fed from cutting rates any time soon.
Job openings in the US have fallen below 10 million, but with just under 6 million unemployed the ratio of openings to applicants is at a historically high of 1.7.
Wade said: “The labour market is headed in the right direction but needs to slow considerably further to turn the direction of policy.”