Jacob Vijverberg, Multi-Asset Investment Manager at Aegon Asset Management, says corporates are battening down the hatches as they prepare for an economic storm.
Corporates are looking to batten down the hatches as economic storm clouds swirl and central banks push on with rate hikes. They are already feeling the effects of a higher interest rate environment and coming under increasing pressure as a result. This leaves central banks with a delicate policy balance to deliver.
Central banks are balanced on a knife’s edge. Inflation still remains well above trend which would imply higher interest rates are needed.
Yet recent market turmoil, particularly in the banking sector, suggests that rate-sensitive corporates are already beginning to feel the effects of tighter financial conditions. Must we persist with higher rates? That is the question for both policy makers and investors going forward.
In the wake of SVB and Credit Suisse, regulators and central banks have been quick to intervene to reassure markets. But given how quickly rates have increased, particularly in Western economies, financial stresses are unlikely the end, and we expect more corporates to face pressure going forward.
The financial sector crisis has left central bankers with unenviable choices. But ultimately the Fed and ECB will continue to hike rates as persistent inflation presents the bigger risk.
The ongoing crisis in the financial sector leaves central banks, particularly in the US and Europe, in a precarious position. Turmoil in the financial sector ultimately leads to a slowdown in lending as banks look to shore up their balance sheets. Higher rates in itself will also lead to a slowdown in growth, due to their impact on interest rate sensitive sectors like real estate and construction.
Lower growth should reduce inflationary pressures. When inflation has returned to or below central bank targets, it could start cutting interest rates to support the economy. This is what markets are now predicting happens. The Fed futures swap curve shows traders expect 50bps in cuts by the end of the year. However, inflation is still well above normal levels of 2%, and the stickier components, particularly services, are yet to show material signs of deflation.
Given central banks’ ultimate goal is to bring inflation down, we expect the ECB and US Federal Reserve will continue to raise rates incrementally despite the pain we have already seen in the banking sector. Corporate earnings are expected to decline, defaults and unemployment will likely rise, and the risk of a hard landing from monetary policy increases. That said, there are also some bright spots. For instance, the energy crisis is abating, as measures to limit the impact negative impact have been successful. Also, in general the economy has been more resilient to the energy shock than previously feared.
