Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
Access both platforms from your single Saxo account.
Credit conditions and real estate are back in focus
Peter Garnry
Chief Investment Strategist
Summary: Leading indicators are still weakening suggesting the US economy could slip into a recession this year and if it does it will most certainly be driven by deteriorating credit conditions which undoubtedly will be a knock-on effect from the current banking crisis. Higher funding costs and more equity issuances in the European banking sector will drive up credit conditions and worsening the slump in European real estate which down 2% again today with Aroundtown down 10%. Sweden will on a country level be the testing ground for how a weakening real estate sector will impact the economy and banks.
A sense of relief, before focus is back on European real estate
Bank, energy, and transportation stocks were leading the gains yesterday in global equities as First Citizens buys Silicon Valley Bank (SVB). The FDIC provided a hefty incentive for First Citizens on top a hefty discount including a $70bn credit line and agreed to cover losses exceeding $5bn on its commercial loans over the next five years and extended a $35bn loan to the bank. It seems that it was a priority for US regulators that it was not one of the big banks that took over SVB, which from a market perspective is a better solution. Higher oil prices yesterday also helped on sentiment in the procyclical segments of the market.
This morning the equity market has attempted to extend its momentum, but it has been faded again with real estate stocks in Europe down 2% with Aroundtown, the third largest publicly traded real estate company, leading the declines down 10% increasing the concerns of a restructuring. We wrote about the weakening European real estate market last week highlighting Aroundtown. The company has real estate properties in the Netherlands, London, and Germany with around 44% asset exposure to office buildings and 31% to residential properties. The dynamics around real estate assets are important because they are big driver of collateral values on banks’ balance sheets and thus a key driver of credit extension in the economy.
The lag factor and why credit is now key to monitor
Real estate and private equity assets are largely what is called level 2 and level 3 assets which means that they do not have an exchange traded price and either have to be inferred from external prices or comparisons to similar assets (that is level 2), and the most illiquid assets are level 3 which are priced used a model. Because many real estate and private equity assets are in those two categories their full impact comes with a significant lag to rising interest rates. But when the valuations finally change it can cause a dramatic impact. The publicly listed real estate companies are now valued at just 0.66 on price-to-book ratio which implies that the market is adjusting lower the outlook for profits but also lower values on real estate assets.
The dynamics that have evolved during the banking crisis are centred around higher funding costs, a fight for deposits leading to higher deposit rates, higher refinancing costs on AT1 capital, and more common equity issuances down the road if AT1 yields remain at present levels. In addition, banks are still part of a intensely regulated industry that is suppressing the structural return on equity. Declining real estate values will amplify all the dynamics above and Sweden will provide a testing ground of what to expect in other countries, because households apply more adjusted mortgages in the financing of real estate than any other country and thus the downside sensitivity to higher interest rates is just higher in Sweden.
Tighter credit conditions will be the natural outcome of the dynamics explained above and will also be the key driver of an economic recession which now looking more and more likely. The US Conference Board Leading Index is down to levels not seen since Q2 2018 and the decline from the peak is close to 7% which is a bit more than the decline from the peak back in 2007 when the US economy entered a recession in December 2007. If take a look at the subcomponent called Leading Credit Index then it shows the tightest credit conditions (the higher the value the more tight credit conditions are) since the Great Financial Crisis, if we look past the conditions during the early months of the pandemic lockdowns.
Latest Market Insights
Quarterly Outlook
-
-
Quarterly Outlook
Equity Outlook: Will lower rates lift all boats in equities?
Peter Garnry
Chief Investment Strategist
After a period of historically high equity index concentration driven by the 'Magnificent Seven' sto... -
Quarterly Outlook
FX Outlook: USD in limbo amid political and policy jitters
Charu Chanana
Chief Investment Strategist
As we enter the final quarter of 2024, currency markets are set for heightened turbulence due to US ... -
Quarterly Outlook
Macro Outlook: The US rate cut cycle has begun
Peter Garnry
Chief Investment Strategist
The Fed started the US rate cut cycle in Q3 and in this macro outlook we will explore how the rate c... -
Quarterly Outlook
Commodity Outlook: Gold and silver continue to shine bright
Ole Hansen
Head of Commodity Strategy
-
Quarterly Outlook
FX: Risk-on currencies to surge against havens
Charu Chanana
Chief Investment Strategist
Explore the outlook for USD, AUD, NZD, and EM carry trades as risk-on currencies are set to outperfo... -
Quarterly Outlook
Equities: Are we blowing bubbles again
Peter Garnry
Chief Investment Strategist
Explore key trends and opportunities in European equities and electrification theme as market dynami... -
Quarterly Outlook
Macro: Sandcastle economics
Peter Garnry
Chief Investment Strategist
Explore the "two-lane economy," European equities, energy commodities, and the impact of US fiscal p... -
Quarterly Outlook
Bonds: What to do until inflation stabilises
Althea Spinozzi
Head of Fixed Income Strategy
Discover strategies for managing bonds as US and European yields remain rangebound due to uncertain ... -
Quarterly Outlook
Commodities: Energy and grains in focus as metals pause
Ole Hansen
Head of Commodity Strategy
Energy and grains to shine as metals pause. Discover key trends and market drivers for commodities i...
Disclaimer
The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website. This content is not intended to and does not change or expand on the execution-only service. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.
Please read our disclaimers:
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
- Full disclaimer (https://www.home.saxo/en-gb/legal/disclaimer/saxo-disclaimer)