Policy Normalization Will Continue To Cause Pain – March 20, 2023

A just-published report examined the timely topic of whether a full-blown banking crisis was taking hold and the implications for the global economic outlook and asset markets. The report concluded that investors were overreacting.

The report noted:

  • It is typical for blow-ups to occur when interest rates and bond yields rise meaningfully. The abrupt shift from extreme policy reflation and asset bubbles to inflation-fighting central bank policies should be expected to cause problems. More blow-ups are sure to follow.
  • The key is determining how many weak links need to snap before there is sufficient contagion to cause a recession and reversal in the anti-inflation policy backdrop. Our research suggests that the world is not yet at that point, but policymakers must backstop the banking system from causing unnecessary contagion. Indeed, such steps were taken last week, although many investors are not yet reassured.
  • The fundamentals of the aggregate U.S. and euro area banking systems have vastly improved over the past 10-15 years. Thus, recent events are unlikely the onset of another global financial system crisis. When the dust settles, large cap U.S. and euro area bank stocks will be appealing for longer-term investors, and we are buyers.
  • The greater risk is among financial stocks in other developed economies that have housing bubbles and household sector debt imbalances. Housing trends in many of these weak link economies are becoming concerning, and a prolonged deleveraging phase will eventually occur. Stay tuned.


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