LONDON, Feb. 1 (Reuters) – (This Feb. 1 story has been corrected to correct the name of the CIO in the “Going Private” section to Nicoll from Nicole)
The end of the era of easy liquidity is over and the impact is still not felt on the global markets, hopefully the pain from the sharp rise in rates and high inflation has faded.
The U.S. and U.K. central banks are cutting more stimulus as they unload their bond holdings, with the European Central Bank soon to join them. Nomura estimates that the three banks’ balance sheets will shrink by $3 trillion this year.
Tech stocks and cryptocurrencies look vulnerable. They are among the riskier assets that have been boosted by cash outflows by central banks struggling with weak inflation and looking for homes in recent years.
“When you have unprecedented monetary tightening, you’re likely to run into issues that may be something hidden like liquidity or something more obvious like pressure in the housing market,” said Guy Miller, chief market strategist at Zurich Insurance Group.
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We look at some potential pressure points.
1/ Dear friends, there is no news
Once the darlings of the age of easy cash, many investors avoided tech stocks, even after the January bounce, because higher rates made it more expensive to price on potential earnings growth in early-stage or speculative businesses.
When economic uncertainty is high, investors often seek reliable returns from dividends to protect their portfolios. That makes companies like Apple ( AAPL.O ), which trades on a dividend yield of less than 1%, look vulnerable.
“We’re at a point where very high valuations in markets have met with much less supportive policies,” said James Harris, chief fund manager at Troy Asset Management. So, the outlook is getting dark.”
Tech companies are reversing the euphoria of the pandemic, cutting jobs after years of hiring sprees. Google owner Alphabet plans to ax about 12,000 workers. Microsoft, Amazon and Meta are laying off almost 40,000 people.
2/ Default risks
Concerns about corporate defaults are rising as rates rise, although concerns about a recession have eased.
Europe had the second highest default rate last year since 2009, S&P Global said.
US and European default rates are expected to reach 3.75% and 3.25% respectively in September 2023, missing pessimistic forecasts of 6.0% and 5.5% in September 2023.
Michael Scott, portfolio manager at Man GLG, said markets had not fully priced in the risk of a higher default.
3/ Go to private
Private debt markets have grown since the financial crisis to $1.4 trillion from $250 billion in 2010.
The largely floating-rate nature of the financing is attractive to investors who can earn high-to-low double-digit returns, and it became popular as the post-2008 rate cuts boosted riskier assets.
Now, a reality check: Higher rates represent a heavier burden on companies as the recession approaches, casting a shadow over their ability to generate enough cash to pay for ballooning interest costs.
“What surprises me is that you’re almost back to calm,” said Will Nicol, chief technology officer for private and alternative assets at M&G Investments. “We’ve gone from a situation where three months ago everyone was talking about the credit cycle going for the first time in decades, and now people seem to have forgotten about it.”
Rising borrowing costs hit crypto markets in 2022. The price of Bitcoin plunged 64%, wiping out about $1.3 trillion from the global cryptocurrency market cap.
Bitcoin has rallied recently, but caution remains. The collapse of various dominant crypto firms, most notably FTX, left investors with huge losses and prompted calls for more regulation.
January brought a new wave of job cuts as companies prepare for the so-called crypto winter, while Genesis Lending recently filed for US bankruptcy protection and owes creditors at least $3.4 billion.
Real estate markets, the first responders to rate hikes, started to falter last year and 2023 will be tough, with US home prices expected to fall 12%.
Fund managers surveyed by BofA see China’s troubled real estate sector as the second most likely source of a credit event.
European real estate is reporting levels of distress not seen since 2012, according to data from law firm Weil, Gotshal & Manges.
How it services its debt sector is under scrutiny, with officials warning that European banks are at risk of profiting significantly from falling house prices.
Real estate investment management firm AEW estimates that the UK, France and Germany could face a €24bn funding gap by 2025. Fortunately, banks’ balance sheets are better at absorbing losses, so few expect a repeat of 2008.
(1 dollar = 0.9192 euros)
Reporting by Kiara Ellisey, Dara Ranasinghe, Naomi Rownick, Elizabeth Howcroft and Yurok Bacheli; Graphics by Kripa Jayaram and Vincent Flasseur. Edited by Dara Ranasinghe and Christina Fincher
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