Era of zero interest rates and free money is over – and now the hangover is starting as the party ends.
Central bank interest rates influence the return available from lower-risk asset classes such as cash and bonds.
Ten-year government gilt is seen as the risk-free rate and any other investment should return more than that to compensate for the additional dangers.
“Two crypto-specialist banks, Silvergate and Signature, have either been liquidated or folded, and Silicon Valley Bank has collapsed within a year of the US Federal Reserve deciding to end its experiment with ultra-low interest rates and Quantitative Easing. As the tide of cheap liquidity flows out rather in, now investors are in the process of once more discovering what risk really means,” says AJ Bell investment director Russ Mould. “SVB was a poorly run bank that took a lot of risk by specialising in one sector. It held its assets in long-dated Treasuries when its liabilities (deposits) could be withdrawn immediately and grew at a meteoric rate when money was at its cheapest, to provide an extreme example of the old saying that ‘bull markets end when the money runs out’.
“Higher interest rates and Quantitative Tightening are designed to both cool the economy (so inflation does not take a hold) and dampen down animal spirits in financial markets so money is not allocated badly, excess risk is not taken, and accidents do not start to happen.
“Except on this occasion, the free money party was simply huge, thanks to more than a decade of zero interest rate policies (ZIRP) and Quantitative Easing (QE), tools which were wielded with even greater vigour by central banks during the COVID-19 pandemic and lockdowns. Now central banks are hiking rates and tentatively withdrawing QE, the post-party hangover is beginning.
“SVB is a case study in point.
“The specialist in providing financial services to tech entrepreneurs boomed during the 1998-2000 technology, media and telecoms (TMT) bubble and then survived the 2000-03 bust (albeit after a major share price collapse).
“The boom was even bigger in 2000-2021 and it now looks like the fall from grace will be all the harder this time, to perhaps raise questions over other (speculative) asset classes which thrived thanks to the colossal fiscal and monetary stimulus applied during COVID and lockdowns, and which may now struggle as the stimulus is withdrawn.”