Market News

BY Melissa Lawford

A blockade of one of the world’s most important shipping straits, a barrage of missiles raining down on the Gulf and surging energy prices have naturally triggered chaos in global markets.

Much of the turmoil has played out in public on stock markets and bond exchanges around the world. Yet pain is also being felt in more shadowy areas of finance too.

“Highly levered positions in all kinds of corners of the market blow up as volatility increases,” Robin Brooks, a senior fellow at the Brookings Institution, wrote on Substack last weekend. “It looks to me like we’re nearing a breaking point on this front.”

One sector is looking particularly vulnerable: America’s $3tn (£2.3tn) private credit market.

“Shadow banking”, as it is often called, was already in trouble. It was grappling with soaring defaults and a flood of withdrawal requests from investors, motivated by fears about artificial intelligence.

Lloyd Blankfein, a former Goldman Sachs boss, has warned of a “fire” risk in the sector.

Now soaring oil prices are certain to pile on more pain.

More expensive oil will feed through into broad-based inflation, as the price of everything from food to clothing rises. That means higher interest rates and a hammer blow to growth. None of that is good for a sector based on lending money.

“An implosion is still not my base case but it’s something that we just have to be a bit concerned about,” says Timothy Rahill, a credit strategist at ING.

Private credit is a term that covers lending by entities that aren’t banks. Typically, it is done by private equity groups who raise funds from investors.

The sector has been growing exponentially. It has expanded by more than a trillion dollars since 2020 to total $3tn at the end of last year, according to Morgan Stanley. City analysts believe it could reach $5tn by 2030.

But the war in Iran and the resultant energy crisis is piling pressure on the business model.

Many private credit lenders borrow short-term and invest long-term. When interest rates are low and expected to fall, that works. But if they start to rise, then private credit lenders could find themselves paying more for financing than they are earning in interest.

The price of Brent crude has soared nearly 50pc since the war began to more than $110 per barrel. Central banks are now ramping up their inflation forecasts and pouring cold water on previous expectations of interest rate cuts. Many investors are instead now starting to anticipate interest rate rises.

“A month ago, no one was expecting that,” says Brooks. “So that is really destabilising for some of the more vulnerable parts of the financial market here in the US.