June 2023

“I do think I want to roll the dice a little bit more in this situation towards subsidized housing.”  Barney Frank, 2003

“Hopefully we will get a little housing boom and everyone will be happy as property values go up.”  George Osborne, 2013

The UK economy was front and centre in June as a surge in inflation prompted a .50% hike in official interest rates, sending mortgage rates to the highest level in fifteen years and prompting the Greek Chorus to bemoan the looming housing catastrophe.  How could we be about to enter our second bust (remember 2008?) in the twenty years since Gordon Brown famously declared an end to boom/bust cycles?  Faithful readers will know the role that “lower for longer rates” and “quantitative easing” have played, but let’s not forget the contribution of subsidized housing.  Ignoring the lessons of the previous crisis where Fannie Mae/Freddie Mac and 105% LTV mortgages stoked a housing boom on both sides of the Atlantic which brought the global financial system to its knees, the UK government rolled out the “Help to Buy” scheme to provide additional financing to borrowers forced to produce larger down payments.  The banks, which had tightened lending standards under regulatory pressure now came under pressure from a government looking to stimulate the housing market ahead of a likely election campaign.  Thus, the genesis of Help to Buy, which provided house buyers with separate financing to achieve pre-crisis leverage levels.  Presto, house price boomlet achieved!     Fast forward ten years and the situation is starting to unravel and the banks are now being pressured to avoid foreclosures for the next year, ostensibly to support customers, but also conveniently lining up with the timing of the next election.  Perhaps a more appropriate quote for the month might have come from Pink Floyd, ”Hanging on in quiet desperation is the English way…”

Elsewhere, recent trends continued to play out.  The Fed announced a widely expected pause in the tightening cycle while emphasizing that data would be the key to the future direction of rates.  Given the resilience of the employment situation it’s fair to assume that we will get at least one more hike in the fall.  The big impact was felt in the yield curve, as the prospects of any cuts continued to move farther in the future.  Risk markets reacted well with the SPX up 8% while credit spreads tightened, and the yield curve (2y/10Y) inverted by another .30%.  In Europe macro indicators remained mixed, with clear signs of economic slowdown and declining inflation in some countries but stubbornly high in others.  Rhetoric from the ECB remains hawkish, but the view here remains that they are close to finishing this cycle.

It was a busy month for news in the banking sector as the second quarter passed into history.  Expectations are pointing to a dreary quarter for investment banking as a deal drought continues in the face of higher borrowing costs.  European IBs continue to shed staff, further unwinding the misguided post-Covid hiring binge.  The cuts are being dribbled into the market by institutions hoping to be the last one standing when the cycle turns, ignoring the fact that the market is structurally unprofitable.  The banks would have had a better chance of decent returns by buying lottery tickets with all the money they’ve invested. 

On a positive note, lending banks will show another strong quarter as they benefit from the last expansion of NIM we will see before it flattens out.  In the US regulators have responded to the regional banking crisis by raising capital requirements on the largest institutions by 20%.  Perhaps they are expecting the larger banks to absorb capacity from problem names?  Or maybe its just easier to do this than to actually work through the issues of the smaller banks.  In any event, banks followed the broader markets higher, more driven by receding fears of an imminent hard landing than anything else. 

Against this backdrop the funds A shares gained 3.08% with credit contributing +336bps in gross performance while equities had a negative -25bps contribution.  As expected, Greek elections confirmed the political and economic continuity that we had expected while moderation of inflation in Southern Europe was also supportive of the portfolio.  As Q2 results are released over the coming months we expect current trends to continue – subject to disruptive economic data – and we will continue to reposition the portfolio to preserve flexibility for the second half of the year.