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Investment Strategy Insights Monthly Views From Our Diverse Global Investment Teams Banking on a Recession, Not a Crisis April Hani Redha, CAIA, Portfolio Manager, Multi-Asset 2023 Images of depositors lined up outside Silicon Valley Bank, alongside UBS’s takeover of rival giant Credit Suisse, certainly paint a picture of the global banking system on shaky ground. In many ways, however, the system may be on sounder footing, in the US and particularly in Europe, than is generally perceived. Today’s banking problems are less about declining credit quality and more about rising interest rates. At Silicon Valley Bank, for instance, the trouble was due to a duration About This Report mismatch, as surging interest rates reduced its US Treasury holdings’ value, while PineBridge believes that not only elevated interest rates prompted its major client base, tech start-ups, to start drying up do differences of opinion make and withdrawing deposits. markets, but they also foreshadow Actions by regulators and government officials – widening the umbrella of deposit substantial moves ahead as these insurance and permitting banks to borrow from the Federal Reserve’s discount window differences are resolved. Once a based on the original value of an asset, rather than its market value – appear to have month, investment leaders from alleviated much of the current stress. Long-term policy implications aside, the question our global multi-asset, equities, will be whether sufficient confidence is restored among the public generally and among and fixed income teams meet to large depositors specifically. share their diverse viewpoints. This In Europe, the stresses are different. Credit Suisse’s collapse was due to longstanding report reflects those discussions struggles in the bank’s franchise, which culminated in significant outflows of deposits and debates by providing insight on and an inability to attract sufficient capital. UBS’s acquisition of Credit Suisse has the topic of the month along with removed a major tail risk for the sector. However, a contagion impact was felt in the snapshots of our asset class views market for Additional Tier 1 (AT1) securities, or CoCo (contingent-convertible) bonds, and convictions across the firm. as AT1s have written down to zero while equity holders are receiving UBS shares. AT1 instruments, created in the wake of the global financial crisis, were designed to absorb losses during a crisis when the capital ratio falls below a previously agreed threshold and AT1s are converted to equity. Yet the expectation was that equity holders would take losses before AT1 holders. To limit the damage, regulators in the EU and the Bank of England have distanced themselves from Swiss regulator FINMA’s decision, emphasizing the hierarchy of creditors in which equity would take losses prior to AT1s. Indeed, Credit Suisse’s failure and its total wipe-out of AT1s were idiosyncratic, rather than indicative of the overall health of the European banking sector. In fact, Europe’s banking sector is arguably more robust than its US counterpart. While the US has rolled back banking regulations for smaller banks since 2018, the EU has upheld stringent regulations and never backed away. Market overreactions may present opportunities for prudent, long-term investors to capture what might be called a panic premium. Our base case assumption is that a financial crisis akin to the global financial crisis will not materialize; however, we do anticipate negative fallout from the banking strains, particularly among regional banks in the US. While we do not foresee cascading bank failures, we do expect credit conditions to tighten and funding costs to rise, adding to the negative momentum of the last few quarters. This, coupled with weakness in the commercial real estate sector – whose debt constitutes a sizeable share of regional bank assets – could pose challenges in the future, probably culminating in a recession. We believe one winner from the pullback of regional banks will be the private credit market. Existing allocations will be challenged, yet fresh capital is now enjoying better credit terms and more attractive pricing. We perceive the ingredients for a good private credit vintage. The PineBridge Global Multi-Asset Series MULTI-ASSET STRATEGY INVESTMENT STRATEGY INSIGHTS CAPITAL MARKET LINE
Conviction Score (CS) and Investment Views
The Conviction Scores shown below reflect the investment team’s views on how portfolios should be positioned for the next six to nine
months. 1=bullish, 5=bearish, and the change from the prior month is indicated in parentheses.
Global Macro Stance: Recent turmoil in the banking sector serves as a stark reminder of financial tightening’s
possible consequences. While financial instability creates a potential path toward recession,
CS 3.50 (unchanged) regulators have taken action to mitigate the likelihood of contagion. The medium term, however,
may see a further tightening of lending standards, either through self-imposed measures or
regulation, which already is quite stringent. Meanwhile, the economy has slowed somewhat since
January but remains robust. In February, the Consumer Price Index increased at a rate of 6.0%
year over year (y/y), as expected, but the Producer Price Index showed signs of disinflation and
supply chain normalization, rising only 4.6% y/y, down from 6.0%. Despite a somewhat softer US
labor market in January, data on initial jobless claims, JOLTS job openings, and nonfarm payrolls
surpassed expectations and suggest continued strength. In China, recovery remains a standout
story, with reopening efforts on track and few concerns about a wobble in first-quarter data.
Outlook: Despite firmer domestic economic data and China’s solid reopening, financial stability
concerns are growing. While contagion is unlikely, signs point to a recession in the second half.
Risks: 1) Inflation falling faster than expected or the Fed looking through services inflation
and pivoting earlier; 2) systemic problems in Europe or the US; 3) more resilient economic
fundamentals across Europe and the US.
Rates The banking system is in survival mode, and we anticipate liquidity pullbacks in every area of
banking. Meanwhile, volatility is unprecedented and won’t let up anytime soon. The two-year
Gunter Seeger, CFA
began February at 4.04%, shot up to 5.08% before the month ended, then rocketed down to 3.64%
Portfolio Manager, Developed
on March 20. That’s a 13-Sigma event, or a move of 13 standard deviations! Meanwhile, the Fed is
Markets Investment Grade
in the ultimate pickle, as attempts to stop inflation rattle the banking system. The highest-yielding
point on the Treasury curve is the fed funds rate. If banks borrow from the Federal Home Loan
CS 3.50 (unchanged) Banks, there is no Treasury security or agency mortgage-backed security (MBS) that yields more
than fed funds. So, banks borrowing money means banks lose money. The Fed’s repo solution
poses the same problem. On the other hand, inflation is still 6%. Printing money and making it
cheaper through rate cuts will not stem the tide of inflation.
Credit The blow to confidence in the banking system due to regional bank failures and the takeover
of Credit Suisse has not completely abated, but the many “bailout” actions have substantially
Steven Oh, CFA
reduced contagion risks. Furthermore, the market’s expectation of future Fed rate hikes has fallen.
Global Head of Credit
In the wake of these developments, however, credit spreads have widened to levels that warrant
and Fixed Income
an improvement in our CS despite the emergence of additional macro risks. While valuations are
far from cheap relative to recession/systemic risks, they are sufficient to reduce the substantial
CS 3.25 (-0.50) underweight in risk levels across many portfolios. With yield curves also declining substantially,
particularly on the short end, fixed-rate credit prices have been reasonably stable despite the
spread widening. High yield (HY) spreads briefly breached +500 levels, and investment grade (IG)
spreads have widened to the +150 area. At these valuations, our prior preference for IG versus HY
has diminished. While floating-rate credit spreads also have widened, the differential compared
with fixed spreads has compressed, resulting in a more neutral stance.
PineBridge Investments Investment Strategy Insights | 2Currency (USD Perspective) The tug of war between “higher for longer” and “monetary policy acting with a lag” likely will
generate higher volatility in the short term. Volatility should subside, however, once US growth and
Anders Faergemann inflation slow, dampening Fed hawkishness. Continuing concerns about the banking system may
Senior Sovereign Portfolio increase short-term volatility, sending global risk markets into a higher volatility regime, which
Manager, Emerging Markets typically is painful for equities and risk assets while benefiting the US dollar. Since the US was the
Fixed Income epicenter of the recent financial sector instability, and the US dollar’s status as an equity volatility
hedge has been eroded, the euro may wind up the winner in the banking turmoil. Rate differentials
remain key for currencies. The European Central Bank (ECB) is likely to remain more aggressive
CS 3.00 (unchanged) than the Fed in tightening monetary policy through June and may be slower in reversing/easing
than the Fed, as the monetary policy lag in the eurozone tends to be longer than in the UK and the
US. We favor using short-term US dollar strength to reposition for a weaker dollar in the second
half of 2023, as we expect US economic activity will fade, and the Fed will pause. Our 12-month
euro/US dollar forecast of 1.1000-1.0500 makes us neutral to mildly bearish on the dollar over
that investment period. The dollar tends to have a negative relationship to global growth and
underperforms emerging market (EM) currencies during periods of a US-only recession. China’s
reopening helps bolster EM activity and supports a widening of the growth differential between
EM and developed markets (DM).
Emerging Markets Despite turmoil elsewhere, current EM risk factors are relatively benign. According to our
Fixed Income vulnerability indicators, the sovereign EMBI investable universe is now less vulnerable than it
was three years ago, and the EM IG universe is particularly robust. Market access is key, but
Chris Perryman large parts of the HY universe can survive this year on support from the International Monetary
Managing Director, Corporate Fund, the World Bank, and wealthy friends, even if some countries are near distressed-debt levels
Portfolio Manager and Head of and should be considered uninvestable. Geopolitical tensions remain high between the US and
Trading, Emerging Markets China, yet unlikely to increase despite the harsher diplomatic tone. Likewise, the China/Europe
Fixed Income relationship has probably already bottomed. The outcome of Taiwan’s election in January 2024
will be critical to the long-term view. EM resilience and strong fundamentals make us optimistic
on the asset class. EM corporate IG offers attractive entry points on a risk-adjusted basis amid
USD EM (Sovereign and Corp.) lower leverage, higher average credit ratings, and considerably shorter duration than US IG and EM
CS 3.00 (unchanged) sovereign IG. Local currency debt offers an attractive alternative to sovereign IG. We are currently
being selective and believe Mexico, Colombia, Indonesia, and South Africa show favorable
Local Markets (Sovereign) attractiveness.
CS 3.00 (unchanged)
Multi-Asset We see four main forces driving the global economy and markets: a slowdown in disinflation, with
goods prices no longer an issue as secular service inflation gains strength; Europe’s avoidance
Peter Hu of an energy crisis, providing consumer confidence and purchasing power; China’s ability to
Managing Director, Portfolio reopen without monetary pullback; and the negative consequences of central bank tightening.
Manager, Global Multi-Asset Despite recent economic data showing signs of strength, we believe this strength is the result of
earlier central bank easing. That is now being reversed with the notable exceptions of the Bank
of Japan (BOJ), which continues to use its balance sheet to defend its yield curve control (YCC)
CS 3.50 (unchanged) efforts, and the People’s Bank of China, which has allowed its balance sheet to surge to prevent
China’s economy from falling apart. We believe the new BOJ governor will likely end YCC in the
next three to nine months and that the Chinese government is now looking to hold back after the
strong economic reopening. The global central bank balance sheet may go back to contracting
mode soon. Furthermore, a strong US economy and a tight labor market only boost the odds
of more Fed tightening, and thus the odds of a harder landing. Discussions with private credit
market specialists have provided us with insightful bottom-up views, particularly for small and
medium-sized enterprises. These companies typically borrow in floating-rate form, which means
their borrowing costs have already risen from 5% to 9%, driving meaningful margin contraction.
Together with banks tightening lending standards, we believe we will see the full impact of tighter
and more costly credit in the second half of the year. Overall, we maintain a cautious risk posture
and see pricing of risk in our Capital Market Line as overconfident, reflected in our below-neutral
Risk Dial Score of 3.5.
PineBridge Investments Investment Strategy Insights | 3Global Equity Macro conditions remain dynamic, with new signals of stress. While contagion is possible in
the banking sector, the Fed and US Treasury reacted quickly to restore liquidity and confidence,
Chris Pettine despite the Fed’s commitment to breaking inflation through higher rates. Companies continue to
Senior Vice President, exhibit optimism in their business outlooks. Many are signaling slow but gradual improvement in
Senior Research Analyst, supply chain and staffing issues. Price/cost relationships are still favorable, but surveys indicate
Global Equities pricing power is trending lower. Earnings estimates also continue to drift lower on macro impacts.
We continue to find market volatility around Fed policy normalization presenting opportunities
to invest in advantaged companies at valuations below typical highs. As always, portfolio style
CS 2.75 (unchanged) balance remains a key component of our risk management.
Global Emerging Our score remains unchanged on little tangible movement in EM despite considerable geopolitical
Markets Equity noise and the DM banking woes. Based on our analysis, there is little risk of Silicon Valley
Bank-style contagion in global EMs, but we are watching developments intently. In China, home
Taras Shumelda appliance and furniture companies are being driven by the recovering housing market. Travel-
Senior Vice President, related demand expectations and investment into artificial intelligence and electric vehicles
Portfolio Manager, remains strong. Smartphone sales have been muted recently. In India, banks continue to witness
Global Equities strong credit growth, while heavy industries including electricity, coal, cement, steel, and energy
also continue to show good growth. With global energy prices coming down, margins of Indian
companies should rise, and inflation should remain under control. In Latin America, there is
CS 2.50 (unchanged) increasing divergence of performance between Mexico and other markets. The former has
emerged as an area of relative political and economic stability in a region that faces multiple
challenges. In Central and Eastern Europe, companies have adapted to the Ukraine war’s impact
and benefit from the low base set in 2022. We continue to engage with portfolio companies with
the goal of improving their ESG attributes and enhancing their long-term prospects.
Quantitative Research Our US Conviction Score deteriorated to 4.25, with contributions mainly from a flatter curve and
wider credit spreads. Our global credit forecasts remain positive on EM and negative on DM. In
Haibo Chen, PhD DM, our industries model favors banking, finance companies, insurance, capital goods, and basic
Managing Director, industry. It dislikes electrics, natural gas, utilities, consumer non-cyclicals, and energy. In EM
Portfolio Manager, countries, the model likes Argentina and Taiwan. Among EM industries it likes metals, real estate,
Head of Fixed Income and financials and dislikes utilities, infrastructure, and transportation. Our global rates model
Quantitative Strategies forecasts lower yields globally and flatter curves in Europe, the UK, and Oceania; a slightly flatter
curve in Japan; and slightly steeper curves in North America. The rates view expressed in our
G10 model portfolio is overweight global duration. It is overweight North America and Japan and
underweight Europe. Along the curve, it still positions for flattening with overweights in six-month,
10-year, and 20-year durations versus underweights in two-year, five-year, and 30-year durations.
All market data, spreads and index returns are sourced from Bloomberg as of 20 March 2023.
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