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INVESTMENT STRATEGY QUARTERLY

from 4% as recently as 1 January) may feel radical, but it is the posited by economist Hyman Minsky was, ironically, just what the
right option when public confidence is to be retained and world’s largest central banks aimed to achieve at the outset of the
contagion avoided. Acting pre-emptively is key and is how Swiss rate hiking process. That it has taken so long for cracks to emerge
authorities have handled Credit Suisse’ folding into UBS too. has much to do with the fact that consumer cash balances were,
initially at least, replete with pandemic relief cash, while wildly
It is no surprise that financial markets reacted as they did, over-reserved banks were insulated from the initial effects of
suffering a barely suppressible fear that just because three US central bank balance sheet run-off, otherwise known as
banks failed and one, admittedly large, Swiss bank faltered must quantitative tightening. With these buffers diminishing, tighter
mean that other banks must follow. However, such fevered lending standards will likely throttle economic activity, exactly
speculation has no rational basis. A commercial bank is in key what central banks wanted at the outset of the rate hiking
respects a unique institution. At heart they are companies like process.
every other, with a fiduciary duty to shareholders to generate
profits. In banking, making a profit involves taking risks and risky So now financial market pricing is in the process of adjusting to
undertakings do not always generate good results, especially the likely imminent onset of recession. Stock markets have,
when developed economy central banks around the world are perhaps counterintuitively, rebounded as March (and the
raising interest rates as aggressively as they have over the past calendar quarter) has come to an end and investors are grateful to
year or more. But banks differ from other commercial entities in the Federal Reserve and its systemic central banking counterparts
that they have an equally important fiduciary responsibility to for the emergency provision of ample liquidity and on a daily, not
depositors, who hand over their money in good faith in weekly basis as was the case before the episode’s onset. But the
anticipation that it will be invested by the bank in safe loans. In main tool in a central banker’s tool kit is the interest rate. Having
this sense, banks are also public utilities; depositors have done, previously priced to anticipate a prolonged pause period once the
and are doing, nothing wrong in holding their money in bank end of the rate hiking process has been signalled, financial
accounts. markets are adjusting to the possibility that that pause period
might be sharply foreshortened before rates are cut as recessions
The only surprise in all this, is that markets were as surprised as are confirmed and inflationary pressures finally quelled. As TS
they were. When central banks embark upon a process of Eliot wrote, “April is the cruellest month, breeding lilacs out of the
monetary policy tightening as quickly and as aggressively as has dead land, mixing memory and desire, stirring dull roots with
been the case something, somewhere was almost bound to spring rain”. As every good gardener knows, the lilac symbolises
happen. Bank of England Monetary Policy Committee member Dr renewal, stirring feelings of hope at the last dissolving of winter’s
Catherine Mann was not alone when recently expressing surprise snowy shroud. There may be more alarms and excursions before
by the economy’s apparent resilience and capacity to withstand finally this book of verse concludes, but markets are at least
higher interest rates, but at some point, a point now clearly shifting onto more familiar ground.
reached, the effects would inevitably start to show up in the most
interest rate sensitive sectors of the economy, especially those
whose business models operate at the interface between KEY TAKEAWAYS:
monetary policy and the real economy. Banks are, in the end, • Regulators and those with responsibility for financial
businesses that are hugely sensitive to changes in interest rates market oversight have acted swiftly to ringfence
and especially to government bond yield curves that have been turmoil in the banking system and restore order to
deeply inverted for some considerable time. financial markets.

Where all the above affects the broader economy, and financial • Residual concerns regarding the consequences
markets by extension, is that any bank facing uncertainty over its of rapid monetary policy tightening remain, but
depositor base, or building in tighter lending standards, will very depositor balances in commercial banks are secure.
likely act to withdraw credit from the economy. Indeed, the latest • Financial markets are adjusting to a seemingly
Bank of England data on bank lending reveals that in the UK this inevitable tightening in credit availability and its
is a process underway since last August. Real bank lending is also likely impact on economic activity.
on a declining trend in Europe and Canada too. It will likely not be • The counterpoint to economic weakness will be
too long, think rapidly repricing financial markets, before banks a more subdued inflation environment and lower
even more generally must be forced to reel in credit to preserve interest rates, perhaps sooner than had otherwise
capital adequacy. A situation in which even well capitalised strong been envisaged.
banks stop lending, a so-called “Minsky moment” after the theory

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