The international banking crisis has exposed how fragile financial stability is. As a result, calls are being made for regulators to intervene more rigorously. However, not all risks can be regulated away, Natixis IM's chief strategist tells finews.com.

Mr Chetouane, how do you see financial stability in the EU after the recent crisis in the banking sector?

The European banking sector has faced several crises over the last fifteen years. As a result, regulation has been tightened considerably, limiting the scope of activities of European banks, but at the same time strengthening their financial solvency.

How can you tell?

For example, core capital ratios of banks in major European countries have increased significantly since the sovereign debt crisis, surpassing those in the United States. On the other hand, central banks have expanded their toolkit to address liquidity and financial stability issues. Therefore, the combination of a strong banking sector and proactive financial authorities is a strong guarantee for preserving financial stability in the euro area.

How are the Fed and the ECB positioning themselves in this environment?

The central banks sent a swift, clear, and strong signal to markets, limiting any contagion effect that could have been triggered by the bankruptcy of Silicon Valley Bank. To a large extent, central banks have learned from previous experiences and have improved their crisis management capabilities by being pragmatic. The cost of a banking crisis is much higher than the cost of containing it.

Do regulatory requirements need to be strengthened?

While there is an ongoing debate about whether additional measures are needed to strengthen the system, The current regulatory framework has so far proven to be effective. It should be kept in mind that imposing a restrictive regulatory framework could penalize the European banking sector, which competes in a globalized environment.

What does that mean?

Regulators need to find the right dose of regulation to preserve confidence in the banking sector and financial stability in times of uncertainty without restricting their development. Any further regulatory requirements would need to strike a balance between promoting financial stability and ensuring that banks are able to support economic growth.

Is there a need for stronger safeguards in the non-banking sector, e.g., hedge funds or alternative investments?

The EU banking sector has undergone significant regulatory changes in recent years, addressing the potential for systemic risk that could hit the real economy. However, regulators should bear in mind that there is a trade-off between continuing to strengthen safeguards in the non-banking sector and the risk of witnessing moral hazard behaviors.

What misaligned incentives are you thinking about?

Stronger safeguards could lead actors in the non-banking sector to take additional risks and likely end up triggering undesired effects. The most efficient manner to address this complicated trade-off would be, in our opinion, to focus in reinforcing upstream controls and regulations.

Where do you see the most important risks right now for institutional investors?

Sticky price environment is a threat because it may lead central banks to raise interest rates to higher levels than anticipated by investors. This will limit access to credit, reducing the supply of credit for businesses and ultimately for households, which will dampen domestic demand.

Rising rates at unexpected levels could also pose a challenge for companies that use bond markets to finance their investments. Refinancing could therefore be much more complicated.

Could rebound of oil prices in the first half of April challenge the expectations of many market participants of a gradual decline in inflation over the coming months?

The rebound in oil prices seen recently was mainly driven by the surprise 1,16 Million barrels per day (mb/d) production cuts until yearend announced by the OPEC+, which come on top of the production cuts of 0,5 mb/d previously announced by Russia. Combining our expectation to see world GDP growing by 1,9 percent in 2023 together with OPEC+ cuts, the oil market is likely to fall into a significant deficit this year in 2023.

Moreover, while oil futures indicate that prices are expected to decline going forward, they are not expected to fall below USD 70 per barrel for the entire year. This should be positive news to see inflationary pressures wane, prices would need to go and consistently remain above USD 90 per barrel to again see positive base effects in the coming months.

Do you expect a new supercycle in commodity markets?

Historically speaking, commodities supercycles have been mostly driven by industrialization or reindustrialization processes which have led to a significant increase in demand. A distinction should be made between energy and non-energy commodities.

For energy commodities, the supercycle hypothesis is difficult to defend because demand is expected to decline in both the short and long term. In contrast, a supercycle scenario for the non-energy commodities group is likely, as demand is expected to soar. Climate change challenges, which will lead to significant changes in the energy mix of many countries, should support this supercycle.

What is your outlook regarding inflation?

When it comes to Europe, there is little doubt that headline inflation will have declined by year end because of the strong negative base effects. However, core inflation is not expected to follow suit, to the contrary, core inflation is likely to continue rising in Europe, supported by both a mark-up effect and the Philipps effect. We do not expect any of these two supporting factors to dissipate before the end of the year.

In addition, the services sector, which is one of the main drivers of core inflation right now, has yet to normalize. Inflation’s stickiness is clearly challenging central banks’ monetary policies and, therefore, we cannot rule out surprising policy decisions along the way.

Mabrouk Chetouane is head of global market strategy at Natixis IM. He has nearly 20 years of experience in macro-economic forecasting. He joined Natixis IM from BFT Investment Managers, where he was head of research and strategy. He also spent 6 years with Banque de France.