Some US regional banks were ill-prepared for the interest rate turnaround, says Christoph Sax, Chief Investment Officer at VZ Vermoegenszentrum. European banks are in a much more stable position than before the financial crisis. However, it is difficult to assess how higher interest rates will affect their balance sheets.
Mr. Sax, what are the three main tasks of your job as Chief Investment Officer?
Generally speaking, I help our customers to retire better prepared, with my work based on the following pillars: First, I am responsible for analyzing the economy and financial markets from a fundamental perspective. Internal and external communication of my assessments is also part of my job. In addition, I participate in defining the investment policy for asset management.
What are the disadvantages of this work?
You spend a lot of time at the computer screen, which is noticeable in my eyes.
What tips would you give to graduates who want to pursue an investment career?
Not to focus only on models and numbers, but to be interested in real life. In company business models, economic policy, or more generally monetary policy, there is a story behind the numbers.
How would you describe your investment process?
Broadly speaking we have diversified investments done largely passively. Our investment philosophy is strongly focused on strategic decisions, we don't engage in experiments, and we operate free of conflicts of interest. No proprietary instruments are used in asset management mandates.
«No proprietary instruments are used in asset management mandates»
What is your interim assessment of the year to date?
I see the glass half full, although the US economy is still likely to slip into recession. The equity markets have started well, even though market breadth leaves something to be desired, especially in the US.
What is currently causing you headaches as a CIO?
What worries me most is the continuing debt growth and the still very high excess liquidity in the financial system.
Do you see a way out of the debt trap?
Demographic change is in full swing, and our society is undergoing structural change. There is a need for action, and we have to face up to the demographic challenges at the economic and political levels.
Inflation remains high. When will we see rates of 2 percent again in the US and the eurozone?
Toward the end of 2024, this should be the case in both currency areas, provided the central banks continue to focus their monetary policy strictly on fighting inflation. Otherwise, inflation is likely to remain somewhat higher for longer.
«Inflation is likely to fall to 2 percent in Switzerland soon, but remain close to this mark thereafter»
How will inflation develop in Switzerland?
It will continue to fall, but more slowly than in the spring, and the appreciation of the Swiss franc has recently contributed to the decline although rising rents are dampening downside potential. Inflation is likely to fall to 2 percent in Switzerland soon, but remain close to this mark thereafter.
Is inflation still driven by supply shocks?
No. We had a supply shock in energy and to some extent in goods trade and food commodities. That's behind us. What is still driving prices is high service sector demand and the tight labor market. The catch-up effects after the pandemic are still having an impact here and the relatively expansionary fiscal policy is also playing a role.
Another issue is «greedflation.» Companies are taking advantage of the inflationary environment to increase their profit margins. In doing so, they are fueling inflation. Does that surprise you?
Not really. In times of scarcity and high demand, there is room for price increases which settles down again as demand slows. This process is already underway in many areas like industry, energy resources, and certain consumer goods.
Are higher interest rates a suitable instrument for combating inflation triggered by rising margins?
Margins were only able to widen so much because supply was temporarily tight and a consumption boom set in after the pandemic. Key interest rate hikes are aimed at dampening demand, and in this respect are entirely appropriate. However, the example of the UK shows that new trade barriers also increase the margin headroom. Prices are rising faster there than in the EU. With geopolitical conflicts, trade barriers have generally increased.
In the US, the Fed has paused interest rate hikes. When can we expect a pause in interest rates in Europe and Switzerland?
The Swiss National Bank is expected to raise its key interest rate by 0.25 percentage points on Thursday. In the eurozone and Switzerland, another rate hike is likely to follow after the summer break. The SNB will probably call it a day after that. The European Central Bank is likely to at least pause.
«In the US, the government is spending much more than it used to, so the Fed has to put the brakes on more as well»
Is the market underestimating the risk of further US rate hikes in the second half of the year?
The markets are assuming that the inflation problem will now be resolved quickly. However, I think the expectation of many investors that the Fed will soon loosen the interest rate screw again is premature. The Fed could still make two more interest rate hikes. In the US, the government is spending much more than it used to, so the Fed will also have to put the brakes on more.
The Swiss economy grew solidly in the first quarter of 2023. Is there a risk that rising interest rates will stifle growth?
The leading indicators point to temporary stagnation, but not to a collapse in economic output. The economy is expected to expand only slightly in 2023 as a whole. A moderate acceleration is likely for 2024.
What is the situation in the eurozone?
According to the latest data, the eurozone is already in recession. In the second quarter, too, the economy is likely to have stagnated at best. But the important thing is that the dip is not particularly deep.
And in the United States?
A US recession is probably only a matter of time. Monetary tightening is having a delayed effect because US households have higher reserves thanks to government support measures during the pandemic. In addition, the government is supporting the construction industry with industrial subsidies. I think we have not yet seen the full effect of monetary tightening, and the Fed will continue to shrink its balance sheet even after the rate hikes.
In the past, monetary tightening has often triggered a banking crisis after a long period of cheap money. In the US, some financial institutions have already collapsed. Is the worst over?
At the moment, it looks that way. But it also depends on how much the Fed still has to raise the key interest rate and, above all, how long it keeps it high. It is conceivable that more regional banks will get into trouble. Smaller banks are less strictly regulated in the US. In some cases, they were ill-prepared for the interest rate turnaround. By contrast, I see fewer problems with the big banks. They will emerge as winners from the industry consolidation.
«Swiss financial institutions are well capitalized and can absorb any credit defaults well»
European banks have recovered in recent years. Depending on the country, however, there are still mountains of bad loans. How stable is the banking sector in the euro area?
Certainly much more stable than before the financial crisis. European banks have more reserves. They have also made progress operationally. But it is difficult to assess how the interest rate turnaround will still affect balance sheets. That's why a certain degree of caution is also appropriate in Europe.
How solid are Swiss financial institutions?
They're solid and also well-capitalized and can absorb any loan defaults well. Credit Suisse was an isolated case.
Higher deposit rates are reducing the profitability of banks, as the industry warns. Do you see this as a threat to financial stability?
I don't see too much of a threat to financial stability. The interest rate turnaround opens up higher earnings opportunities in the long term: net interest margins will rise. But in the short term, profitability may suffer - especially if balance sheets are not sufficiently hedged against interest rate changes. Many banks have large mortgage portfolios with fixed maturities and low-interest rates. However, refinancing costs have risen.
In Switzerland's leading stock market barometer, the SMI, the weighting of bank stocks has roughly halved over the past 20 years. What does this say about the Swiss financial industry or the stock market?
On the one hand, it reflects the relative loss of importance of the financial sector. On the other hand, it also shows that passive investors who back Swiss equities are now taking fewer cluster risks and are even better diversified.
Let's assume we meet again in a year. What stock market topic would we talk about then?
The first cuts in key interest rates and a related brightening of the economic outlook.
Christoph Sax has been Chief Investment Officer at VZ Vermögenszentrum since 2022. Before that Sax, who holds a doctorate in economics from the University of Basel, was Chief Economist at Migros Bank for about five years. Before joining Migros Bank, the 47-year-old watersports enthusiast and father of two was, among other things, Deputy Head of Financial Analysis at Luzerner Kantonalbank. Before that, he worked for several years as an economist at the State Secretariat for Economic Affairs (SECO), first in the Directorate for European Affairs, then as Deputy Head of the «Macroeconomic Support Division.»
