February 2024

“If I’ve made myself clear, I’ve misspoken.”  Alan Greenspan

Once upon a time central bankers prized discretion over transparency and didn’t produce such thing as Dot Plots and public forecasts of the direction of interest rates over the next two years.  To be sure, Mr Greenspan himself succumbed to the Too-Much-Information fad in his last tightening cycle as Fed Chairman, raising rates gradually and with full transparency, perhaps contributing to the excessive market leverage pre-2007.  Ever since then we’ve been inundated with Forward Guidance, explicit direction on timing and magnitude of rate moves, and a non-stop commentary from an endless list of obscure committee members, all with the stated objective of reducing volatility.  But has this really worked?  In the days of central bank omerta, the rule was “I reserve the right to change my mind if the facts change”, which worked because the market never really knew exactly what the central banker was thinking.  Does this still apply in the days of complete transparency of thought and intent, or is it harder to change direction once positions have been made public?  The “inflation is transitory” period would support the latter, as does the current environment.  For the past six months the market has been gripped by feverish speculation about rate cuts, egged on by official talk.  Inflation has fallen, no doubt, but that alone will not drive the multiple cut scenario priced earlier this year.  In fact, with each piece of strong data the timing of future cuts is being pushed further and further back and it wouldn’t be a complete shock if no cuts were to happen for quite some time, at least in the US.  At this point, the market has given back roughly half of the drop in yields since the December pivot, which we believe is healthy as the positioning imbalance is being reduced.  Perhaps this would be a good moment for central bankers to declare victory and revert to a less-is-more communication strategy?

While yields were rising throughout the month the reaction from risk markets remained constructive, particularly in equities.  While considerable attention was focused on the performance of AI related stocks it is worth noting that European markets outperformed their US counterparts, a function more of the disparity in valuations rather than growth outlook.  Stronger equities with higher rates are a sure sign that a Good-News-is-Good regime is in effect, but in the case of Europe we will either need to see rate cuts to sustain the momentum, or economic growth, which has been as rare as strong political leadership.  At what stage do higher rates start to hurt other markets?  That will be a function of the speed of any upward adjustment, as well as a shift in focus back to sovereign sustainability, something we’ve highlighted in the past.  In the meantime, the market seems comfortable with the idea that we may not get a soft landing but rather a “fly-by”, but that idea won’t last.  It’s worth noting that the Nikkei finally got back to 39,000, a level last seen in 1989-90, as Japan moves past the “Lost Decade”.  It’s also worth noting that at that time the SPX was 353….

It was a very busy month for European financials as results season formally got underway.  The overall theme was that the market rewarded positive news – either earnings beats or large capital repatriations – while brutally punishing any disappointments.  Earnings growth remains elusive for those institutions with more complex business models unable to fully benefit from NIM expansion, and once again CIB businesses were a drag.  Most banks sounded caution of the future direction of NIM, but that shouldn’t prevent lenders from continuing to accrete more capital in the coming year.  Provisioning was higher than 2023 but still benign with two noteworthy exceptions.  Motor finance in the UK, where Lloyds led the way with a £450 million charge that may grow as the regulator further investigates, and CRE, which is a major issue for German banks.  Last month we highlighted the woes of Deutsche Pfanbriefbank (PBB), who also had a difficult February getting downgraded by a rating agency and seeing their AT1s trade to levels below CS’s ahead of that fateful weekend last March.  Recall that results will be released in early March, and with no funding or liquidity stresses to catalyze any action, this will be an important look at the state of affairs.  PBB is not alone among German lenders in having significant CRE exposure as once again Landesbanks have shown an uncanny ability to find the worst traffic to play in (see also the Russian debt crisis, the Tech Bubble, US residential mortgage collapse etc).  While not systemic for the market as a whole, the evolution of this issue will no doubt result in losses that could be problematic for some institutions.  The cumulative effect was to create a negative environment for AT1s, with the typical issue falling by ¼ to ½ a point, albeit with considerable dispersion among banking names.

Against this mixed backdrop the fund’s A shares rose +40 bps with fixed income contributing +63bps gross and equities -14bps.  We came into the month defensively positioned and retained that stance throughout as we believe there is excess complacency in the market given potential negatives, some of which have been highlighted above.  We ideally would like to see more clarity on the outlook for rates or at least a more balanced market perspective, and more transparency on the scale of CRE exposures, both of which will be very influential on near term direction.  We remain very well-positioned to take advantage of any disruptions.