PERSPECTIVE3-5 min to read

Commentary: The Psychology of Trust

They say trust takes years to build but only seconds to break. In a matter of days, trust in the global banking system came into question, culminating in some of the largest bank failures in history. Investors are now trusting central banks to cut interest rates to avert contagion, but is their trust well-founded?

RRF - March Commentary Image


Sebastian Mullins
Deputy Head of Multi-Asset

Trust is the cornerstone of any relationship. This is not only true for personal relationships – it is the foundation on which banking was built. You trust your hard earned money with a bank, whose job it is to keep your money safe. Even though they lend this money out (for a profit), you trust that your money will be there for you when you need it. Trust is hard-earned – it takes years to build but only seconds to break. For the first time since the global financial crisis (GFC), we saw what happens when trust in banks is lost. The banks break.

Banks were viewed as one of the preferred sectors over the past couple of months. The belief was that banks would be safe going into a downturn, given the raft of regulation post the GFC. Valuations were still cheap, and net interest margins were expanding, despite an inverted yield curve. Banks could continue to lend long-term for a profit by not passing on the full extent of rate rises to their depositors. This, unfortunately, could not last and became their undoing, as depositors withdrew their money for the safety and higher yield of treasury bills or money market funds, or simply shifted deposits from less secure regional banks to more globally systemic (and more highly regulated) mega banks. Certain banks had difficulty managing these deposit outflows as they we forced to sell their most liquid assets (mostly US Treasuries) at a loss to their book value, which depleted their excess capital. Within days Silicon Valley Bank (SVB) and Signature Bank became the second and third largest bank failures in US history. A week later, Credit Suisse was forced by the Swiss regulator to be acquired by UBS to prevent another calamity. For perspective, Credit Suisse’s balance sheet is around twice the size of Lehman Brothers’ when it collapsed, at around 530 billion Swiss francs at the end of 2022. In less than a fortnight, the market went from debating the robust economy and interest rates needing to be higher for longer, to believing the start of the next global financial crisis was upon us, and that rate cuts were needed imminently.

Ghosts of 2008

It’s likely too early to determine whether or not this is a flash in the pan, or the start of something systemic. The S&P500 fell over 18% from the peak in 2007 to the collapse of Bear Sterns in March 2008, after which the market rallied 12% over the coming months as investors assumed the worst was over after they were acquired by J.P. Morgan. Six months later, Lehman Brothers and Washington Mutual collapsed and the market fell another 46% to the March 2009 low. We think that is why after the collapse of SVB this month, the market moved quickly to price in interest rate cuts. The 2-year US treasury yield collapsed, falling 130bps, which was the largest fall since the 1987 stock market crash, or to put it another way, the one-week move was a 7.3 standard deviation event. The markets were trusting the Fed would step in and cut rates to aid market stability, given the lingering memories of 2008.

However, one could argue that this is par for the course when trying to undo decades of excess on the back of ultra-loose monetary policy. The most aggressive rate hiking cycle in modern history was bound to cause stress, and those who benefited the most from excess liquidity are now the most vulnerable. This makes SVB and Signature Bank prime candidates, with the latter having almost 25% of its deposits from crypto clients and the former almost exclusively servicing tech venture capital (not to mention seemingly incompetent risk management to boot). The Fed stepped in with the Bank Term Funding Program (BTFP) to specifically provide liquidity to banks to meet redemptions in exchange for their US treasuries as collateral. This injection of liquidity helped stem the bleed and avoid (so far) broader contagion, however in our mind, it also provided cover for the Fed to continue focusing on inflation.

Volcker or Burns?

The market was surprised that the Fed hiked by 25bps this month during a perceived banking crisis. However, Powell has mentioned that rate hikes are used to fight inflation, and that the Fed has ‘other tools’ to help contain the damage if things start to break along the way. So far he is sticking to this playbook. There were nearly 300 US bank failures in the early 1980s, but this didn’t prevent Volcker from hiking aggressively, even in the face of rising unemployment. If Powell dithered at the first sign of trouble, he would have lost all of his inflation fighting credibility. Therefore it is perhaps premature to trust that the Fed will come to the rescue with rate cuts while inflation remains uncomfortably above target. If so, the economic cycle is likely to take longer to play out than markets expect and rates may have to rise again as these expected rate cuts come out of the curve.

Markets appear mispriced

Despite all of the above and after falling 4.5% intra-month, global equities ended up 2.8% by the end of March. We find it difficult to outline a bullish scenario for equities at these levels. Equities have been supported as falling bond yields support higher equity multiples. However, it seems unlikely central banks will cut rates aggressively without a recession, and equities have likely failed to price in the accompanying contraction in earnings if this were to eventuate. A typical ‘cyclical’ recession could see overall earnings decline by around 15-20% in the US, but a recession accompanied by a banking crisis, like the GFC, can see earnings fall much further. Current market expectations for earnings for 2023 in the US are flat. Equities therefore seem to be pricing in the best of both worlds – aggressive reduction in interest rates, but without any dent in earnings.

Alternatively, if the banking crisis is contained, rates will then return to being higher for longer, causing earnings to moderate and equity multiples to de-rate to align with the stubbornly high inflation regime. In the US, PE multiples are currently above 18x. Historically, when inflation is between 4-6%, the average PE ratio is below 15x, showing the potential for significant de-rating if we stay in a higher for longer regime.

Credit spreads blew out over the month but ended only modestly wider than they were at the start. Global high-yield valuations are neutral, which we believe is too complacent, given the risks. This implies default rates will be in line with a normal cycle, not a recession. Before the recent banking turmoil, loan officer surveys pointed to a significant tightening in lending standards, which is usually a precursor to higher credit spreads. The recent events will likely see banks step further away from lending, which will put strain on corporates to attain bank financing. With next to no new issuance in the high-yield market, lower quality corporates may struggle to raise capital, which could see spreads jump from their current sanguine pricing to a potential credit stress scenario.

Preparing for the downturn

The quick shift in sentiment this month highlights the danger of investing in markets where short-term movements are based on trust. Trust that inflation will fall back down to target, trust that central banks will prioritise growth and market stability over fighting inflation and trust that corporate earnings will remain resilient in the face of the most aggressive rate hike cycle since the 1970s. While trust may be the cornerstone of relationships, to us scepticism is the foundation of sound investing.

We continue to believe that the Fed will likely keep rates higher for longer than the market is expecting, and that the resulting recession will be worse than markets are pricing. While this will likely take time to play out, we hold a negative view on equities and high yield credit which we believe are most mispriced in this scenario. Sovereign bonds will protect portfolios in any downturn, but may suffer short term as the market adjusts to remove rate cuts from their forward pricing. In the meantime, investment grade credit remains attractive and can provide high quality carry as these adjustments flow through. If we shift our thinking to a more imminent recession this would supports a case for rebalancing, increasing duration and further reducing credit exposure.

Important Information:

This material has been issued by Schroder Investment Management Australia Limited (ABN 22 000 443 274, AFSL 226473) (Schroders) for information purposes only. It is intended solely for professional investors and financial advisers and is not suitable for distribution to retail clients. The views and opinions contained herein are those of the authors as at the date of publication and are subject to change due to market and other conditions. Such views and opinions may not necessarily represent those expressed or reflected in other Schroders communications, strategies or funds. The information contained is general information only and does not take into account your objectives, financial situation or needs. Schroders does not give any warranty as to the accuracy, reliability or completeness of information which is contained in this material. Except insofar as liability under any statute cannot be excluded, Schroders and its directors, employees, consultants or any company in the Schroders Group do not accept any liability (whether arising in contract, in tort or negligence or otherwise) for any error or omission in this material or for any resulting loss or damage (whether direct, indirect, consequential or otherwise) suffered by the recipient of this material or any other person. This material is not intended to provide, and should not be relied on for, accounting, legal or tax advice. Any references to securities, sectors, regions and/or countries are for illustrative purposes only. You should note that past performance is not a reliable indicator of future performance. Schroders may record and monitor telephone calls for security, training and compliance purposes.

The views and opinions contained herein are those of Schroders’ investment teams and/or Economics Group, and do not necessarily represent Schroder Investment Management North America Inc.’s house views. These views are subject to change. This information is intended to be for information purposes only and it is not intended as promotional material in any respect.


Sebastian Mullins
Deputy Head of Multi-Asset


Follow us

Please consider a fund's investment objectives, risks, charges and expenses carefully before investing.

The website and the content included is intended for US-based financial intermediaries (and their non-US affiliates) on behalf of those of their clients who are both (a) not “US persons” as that term is defined in Rule 902 under the United States Securities Act of 1933, as amended (the “1933 Act”) and (b) “non-United States persons” as that terms is defined in Rule 4.7(a)(vi) under the Commodity Exchange Act of 1936, as amended. None of the funds described herein is registered as an “investment company” as that term is defined in the United States Investment Company Act of 1940, as amended, and shares of the funds described herein have not been and will not be registered under the 1933 Act or the securities laws of any of the states of the United States. The shares may not be offered, sold or delivered directly or indirectly in the United States or for the account or benefit of any “US person.”

The information contained in this website does not constitute an offer to purchase or sell, advertise, recommend, distribute or solicit a subscription for interests in investment products in any Latin American jurisdiction where such would be unauthorized. The information contained in this website is not intended for distribution to the public in general and must not be reproduced or distributed, entirely or partially to any individuals who are not allowed to receive it according to applicable legislation. The investment products and their distribution may not be registered in Latin America, and therefore may not meet certain requirements and procedures usually observed in public offerings of securities registered in the region, with which investors in the Latin America capital markets may be familiar. For this reason, the access of the investors to certain information regarding the investment products may be restricted. Financial intermediaries and Advisors must ensure the information provided in this website is appropriate and suitable to the receiver’s domicile and jurisdiction and according to the applicable legislation.

For illustrative purposes only and does not constitute a recommendation to invest in the above-mentioned security/sector/country.

Issued by Schroder Investment Management (Europe) S.A., 5 (“SIM Europe”), rue Höhenhof, L-1736 Senningerberg, Luxembourg. Registered No. B 37.799

Schroder Investment Management North America Inc. (“SIMNA”) is an SEC registered investment adviser, CRD Number 105820, providing asset management products and services to clients in the US and registered as a Portfolio Manager with the securities regulatory authorities in Canada.  Schroder Fund Advisors LLC (“SFA”) is a wholly-owned subsidiary of SIMNA Inc. and is registered as a limited purpose broker-dealer with FINRA and as an Exempt Market Dealer with the securities regulatory authorities in Canada.  SFA markets certain investment vehicles for which other Schroders entities are investment advisers.

Schroders Capital is the private markets investment division of Schroders plc.  Schroders Capital Management (US) Inc. (“Schroders Capital US”) is registered as an investment adviser with the US Securities and Exchange Commission (SEC).  It provides asset management products and services to clients in the United States and Canada.  For more information, visit

SIM (Europe), SIMNA, SFA and Schroders Capital are wholly owned subsidiaries of Schroders plc.