Even after three consecutive quarters of losses in both equities and bonds, investors may not be out of the woods. So far, it has been a painful, but orderly repricing of risky assets. Now, we fear something worse – a liquidation.
Why might this happen? First and foremost, there is now an alternative. According to Bloomberg, the official US Federal Funds Rate is now in excess of 3%, and US investors can access similar interest rates by investing in regulated money market funds (MMFs), which currently offer about 2.8%.
Never mind that banks are still only offering derisory rates of interest on savings accounts. US investors now have access to safe savings vehicles offering interest rates of almost 3%.
Current market forecasts provided by Bloomberg suggest that US interest rates will exceed 4% by the end of the year, a level MMFs look likely to match. History suggests that when interest rates move above 2%, investors start to take notice. A 4% return on cash may prove irresistible.
Savers pushed towards more risky investments in equities and credit, as an alternative to near zero interest rates, are probably now nursing hefty losses. How long before they decide they have had enough?
Two further reasons
There are two further reasons why a switch out of equities and credit could see a liquidation event in financial markets, rather than the gradual withering of asset prices seen so far this year.
Regulators, mindful of the high risk of a global recession in 2023 and haunted by memories of the 2008 financial crisis, are discouraging commercial banks from expanding their balance sheets. Meanwhile, the same banks face growing demands from companies in the real economy to fund inventories rising simply because of current inflation. These are profitable loans and look certain to receive priority over lending to financial institutions.
The search for yield drove many investors to seek extra income by tying up funds in illiquid investments such as private equity and private debt. If there is a rush to shift money into safer yet higher-yielding assets, only a small pool of liquid assets can be sold quickly.
Current events suggest now is not the time to be more optimistic. As Ian Dury sang in 1979, it may be time for “a bit of grin and bear it” before we can look for “reasons to be cheerful”.
Charles Auer is an investment associate at Ruffer
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