Signs of pain as easy cash era ends are growing

The easy-cash era is over and markets are feeling the pinch from the sharpest jump in interest rate in decades.

The collapse of US-lender Silicon Valley Bank (SVB) in early March after heavy losses on its bond portfolio as rates climbed was a wake-up call for markets that monetary tightening will likely bring more pain.

Since late 2021, big developed economies including the United States, euro area and Australia have raised rates by almost 3,300 basis points collectively.

Here’s a look at some potential pressure points.

1/ BANKS

Banks remain at the top of the worry list after the collapse of SVB, as well as Credit Suisse’s forced merger with UBS, sparked turmoil across the banking sector.

Investors are alert to which other banks might be sitting on unrealised losses in government bonds, the prices of which have dropped sharply as rates have risen.

The SVB bond portfolio losses have highlighted similar risks for Japanese lenders’ gigantic foreign bond holdings, which carry over 4 trillion yen ($30 billion) in unrealised losses.

Japanese, European and US banks stocks, while off recent lows, are still well below levels seen just before SVB’s collapse.

2/ DARLINGS NO MORE

As the SVB collapse showed, stress in the tech sector can quickly ripple out across the economy.

Tech firms are reversing pandemic-era exuberance, with Google owner Alphabet (GOOGL.O), Amazon (AMZN.O) and Meta (META.O) in March conducting their latest rounds of layoffs after years of hiring sprees.

Housing markets in US tech hubs such as Seattle and San Jose are cooling more rapidly than in other regions, real estate broker Redfin Corp says.

In commercial property, a restructuring by Pinterest (PINS.N) will see the social media company exit office leases.

Investors wary of global stress should keep their eyes on Silicon Valley, as ructions in this major US industry cause aftershocks in Europe and beyond.

3/ DEFAULT RISKS

Rising rates pose a threat to sub-investment grade companies, which have to pay up when refinancing their maturing debt and risk defaulting on it.

S&P expects US and European default rates to reach 3.75 per cent and 3.25 per cent, respectively by September, more than double the 1.6 per cent and 1.4 per cent in September 2022. Pessimistic forecasts of 6.0 per cent and 5.5 per cent not “out of the question”, it says.

Deutsche Bank strategist Jim Reid wrote this week that “corporates are more levered now than during the great financial crisis and this cycle could ultimately be more corporate default focused versus financials.”

4/ CRYPTO WINTER

Having benefited from an influx of cash during the easy-money era, cryptocurrencies have felt pain as rates rose last year, then gained on recent signs that tightening could end soon.

The most popular cryptocurrency, bitcoin, has been an unexpected beneficiary of broader market turmoil, surging around 40 per cent in just 10 days.

Analysts attributed the gains to market expectations that rate hikes were nearing their peak, support risk-sensitive assets such as bitcoin .

But there are reasons for caution towards crypto assets — the collapse of various high-profile crypto firms last year left crypto customers shouldering large losses, while US authorities are increasingly cracking down on the crypto sector’s largest players.

5/ FOR SALE

Rising rates operate with a time lag, which means the impact on rate-sensitive housing markets has yet to be fully felt.

A distressed debt index compiled by law firm Weil Gotshal & Manges showed that real estate remains the most distressed sector by some margin in Europe and the UK.

Economists are also worried that commercial property could be the next shoe to drop if global banking woes trigger a broader credit crunch for the multi-trillion-dollar sector that was already under pressure.

Capital Economics said that US commercial real estate (CRE) prices have fallen by 4-5 per cent from their peak in mid-2022 and expects a further 18-20 per cent drop.

The reliance of the sector on lending from small and mid-tier banks — which provide about 70 per cent of outstanding loans to CRE — is worrisome as those banks are facing pressure on their deposit base, the firm noted.