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Michael Graham
Valuations manager
Ascend by Cirium
In the world of investing there is one piece of wisdom which often gets repeated at times of market turmoil, “You don’t fight the Fed!” Or to put it another way, if monetary policy is being tightened by the US Federal Reserve, causing interest rates to rise and the capital value of bonds to fall, then it is prudent not to be on the “wrong side of the trade”. However, what happens if it feels like the Fed is fighting you, as it must have done in the board rooms of Credit Suisse, Silicon Valley Bank (SVB) and Signature Bank over the past couple of weeks?
At this point, it is important to say that the reasons behind the demise of these financial institutions are mostly not shared. What was for SVB and Signature, was more akin to a traditional bank run, not helped by a highly concentrated depositor base backed by volatile long-dated government bonds. In the case of Credit Suisse, a once strategically important bastion of the European banking industry, poor governance in the period since the Global Financial Crisis is largely to blame. The proverbial straw that broke the Swiss camel’s back appears to be a decision by its largest shareholder, Saudi National Bank, not to commit further investment, even as the Swiss National Bank (Switzerland’s central bank) offered to lend up to $54bn to Credit Suisse. In a world of rapidly increasing interest rates, the respective weaknesses of CS, SVB and Signature Bank came to the fore.
When it comes to aviation finance, the market ructions of the past couple of weeks raise a number of questions, to which we do not yet know the answers.
Firstly, will a new “risk-off” sentiment in the banking sector reduce the appetite for financing aviation assets?
Secondly, with increasing interest rates already pushing up the cost of debt for lessors and airlines, what direction will monetary policy take in 2023? Empirical research tells us that monetary policy works via long and variable lags. In other words, interest rate increases from last year may only now be beginning to feed through to the real economy, both in terms of inflation and the cost of borrowing. One may reasonably conclude therefore, that the events of the past couple of weeks may give central bankers cause to pause any further rate rises, for fear of tipping already vulnerable economies into recession. This could potentially be good news for a heavily indebted aviation industry.
However, as the chart above shows US inflation remains well above the Federal Reserve’s target of 2%, and is continuing to push up costs for businesses and push down the earning power of consumers. Therefore, the Fed along with the ECB and Bank of England may have no choice but continue with monetary tightening in order to vanquish inflation, despite the pain being caused in some sectors of the economy. The final question is if this pain was to make itself felt through a recession, will the recovery in global passenger traffic, which is traditionally correlated to GDP growth, encounter turbulence?
Demand uncertainty has been the byword of the past three years, but as the world emerges from Covid, there were hopes that certainty might replace uncertainty.
But to end on another cliché, this latest potential crisis increases that spectre again – the more things change, the more they stay the same.
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