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Insight - Making Sense of the Narrative


The multi-polar world emerging is producing a new 'Dollar Zone' of NATO plus Japan and S Korea. Investors need to start thinking what this will mean for capital flows.

SVB was a shock as everyone assumed everyone else had done the due diligence, but in reality it is a simple story of a bank that became a bond fund and failed to manage its duration and funding risks only to be hit with the equivalent of a redemption as its almost entirely corporate deposit base asked for their money back. By contrast Credit Suisse is hardly a surprise, but coming at the same time, and also in options expiry week, helped to create an exaggerated sense of a banking crisis. There isn't one. Both banks are the collateral damage of the shift to a new New Normal, where interest rates are set at 'normal' levels and normal companies can make normal profits (while great companies can make great profits). Investors should use the sell off from expensive end of fair value to cheap as an opportunity to renew or place their bets on the likely winners under this new paradigm.

SVB is a poster child for the old New Normal. It relied on deposits from the beneficiaries of the Silicon Valley deal machine that it then recyled into largely governmnet bonds on a carry trade that it convinced itself was risk free. However, even as the deal machine ground to a halt due to a lack of liquidity, it ignored its own duration and a liquidity mismatch (on-demand deposits, mostly with no Federal Insurance, invested in longer duration bonds) and when forced to acknowledge the mark to market losses as bond prices collapsed, it also found that an inverted yield curve has taken away its ability to run a carry trade. This is the new New Normal, where normal companies can make normal profits from normal interest rates. As investors start to look through accounting tricks like hold to maturity valuations and non GAAP earnings, Central Banks should also pause in their new found inflation fighting zeal and recognise the impact of inverting not only the yield curve, but the business models of the old New Normal too rapidly.

This is a video I recorded with Neil Shah at Vantage around three weeks ago when I was passing through London. Similar to the CISI subject but with more detail on the work we are doing with Toscafund.

Short covering drove markets in January, then February saw some rebalancing flows before increased Geo-Political tension led to some tail risk hedging ahead of the March options expiry. Traders are thus waiting for direction, while asset allocators are looking at relative value trades and not buying into the macro pundits belief that everyone else is wrong. Longer term investors meanwhile may have stopped selling rallies, but they haven't really started buying dips. Finally, as long term investors start thinking about de-dollarisation in 'The Rest' of the world, we should consider moves to 're-dollarise' the West.