Risks unfold slowly and then burst all at once. Nowhere is that truer than in the banking sector, where the jump to default risk can occur swiftly in times of financial stress. With the default of US regional banks and the forced merger of the two largest Swiss banks, credit spreads soared, and rates volatility went berserk.
The MOVE index – the implied volatility index for bonds – reached levels last seen at the height of the global financial crisis. The cumulative intraday moves of government bond yields at times surpassed 100 basis points. Consequently, investors got whipsawed as markets tried to digest the robust economic and high inflation data on the one hand, and the prospect of a deeper recession and possible banking crisis on the other. Although the emergency interventions by the Fed and SNB saved the system from contagion, the damage might already be done. Lending standards are almost guaranteed to tighten further, which will weigh on future economic growth and could lead to defaults of weaker companies. At the same time, central banks may hike policy rates higher in the near term with inflation becoming more entrenched. We thus foresee further credit spread widening ahead and remain defensively positioned. With the interest rate path being uncertain at this point, we prefer duration to stay close to benchmark but expect rates to eventually fall throughout the year as the economies weaken.
