Immediate fear of banking sector contagion appears to have eased even by late March – replaced, however, by a wider concern about the impact of higher rates on the economy and central banks’ ability to contain the inflation beast as rate hikes bite more deeply. More than half of survey respondents rated inflation outcomes as a high risk factor and almost as many are worried about the domestic housing market, whereas only one-third cite banking sector contagion via a credit squeeze as a high risk (see chart 1). 

Perhaps the biggest question for the economy in the coming months, investors appear to believe, is how successfully central banks will manage the conflicting demands of persistent inflation and the negative impact of restrictive monetary policy. Opinions are split on the what the outcome of this dichotomy will be: half of survey respondents expect the Australian cash rate to be higher than the current 3.6 per cent in 12 months’ time while almost as many anticipate rate cuts, for instance (see chart 2).

The general expectation seems to be of near-term pain that eases, to some extent at least, further toward the horizon. Investors believe the worst of Australian house price falls should be played out by the end of this year and that unemployment will rise gradually but not catastrophically over 2023 and 2024 (see charts 3 and 4). Fitch’s analysts write: “It is something of a negative story, in which stubborn inflation is holding back investor confidence. The pessimistic credit outlook is built around inflation and therefore expectations of higher interest rates, which also has an impact on the property market.”

But Fitch also notes the somewhat better outlook for next year, adding: “It is, however, a relatively short-term negative outlook. For instance, while there are no expectations of higher house prices in 2023 there is more optimism about 2024. Neither do any investors expect unemployment to rise as high as 5 per cent by the end of next year. It seems the expectation is for a tough 12 months but better times ahead.”

The overall outlook on economic direction and the ongoing inflation battle is naturally echoed in investor expectations for credit conditions. The property sector and overall economic conditions are the main risk factors investors cite for bank credit quality in the year ahead, though in this case contagion risk and access to funding are more prominent than monetary and fiscal policy (see chart 5).

It is worth noting, however, that expectations of wider spreads are more limited – even for financial institutions – than they have been in several previous iterations of the Fitch-KangaNews survey. In fact, widening expectations across financials and corporates are roughly at the mid-point of survey outcomes from the past half-decade.

This is reflected in responses to a survey question about what credit spread investors would pay for specific asset classes. The responses are elevated but not out of line with historic results (see chart 10). This appears to match primary market outcomes since the risk events of late March: deal flow has returned and the buy side has been constructive for borrowers willing to meet a revised pricing environment. 

This is not to say investors are completely unconcerned about availability of credit in capital markets. Just 14 per cent of survey respondents predict no significant refinancing challenges for any sector – by far the lowest since this option was made available in the survey, in 2017 (see chart 11).

Structured finance appears to be a particular investor focus. Nearly half of all survey respondents expect it to have the greatest refinancing challenge in the year ahead but many also anticipate this will provide an opportunity. The dichotomy is reflected in investors’ most and least favoured asset classes, where structured finance becomes the first option in the history of the survey to appear in both groups in the same set of response data (see chart 12).

Fixed-income investors also appear to believe their sector will be the place to be in the coming year as “outside fixed income” is the least favoured asset class for the first time in the survey’s history. Confidence that bank woes will remain idiosyncratic rather than system-wide appear to be reflected in the prominence of the financial sector in the most preferred options for a new dollar of investment assets. At the same time, the disappearance of the sovereign sector as a nonprefferred option perhaps speaks to the expectation of a flight to quality.

Another sign of what may be a more positive outlook ahead is investors’ expectations for duration. More than 40 per cent anticipate adding duration over the next 12 months (see chart 13) – a record for the survey – though this may also reflect a significant shortening of duration preferences ahead of the survey and thus more a return to normal than an extension.