What can break even when interest rates rise?

LONDON, June 29 (Reuters) - Markets are on the lookout to determine which sectors will not survive the sharp rise in interest rates in recent decades. Big interest rate changes this month in Britain and Norway are reminders that the squeeze is not over. The International Monetary Fund warns that central banks may need more time to bring inflation down, and a fresh wave of financial turmoil could make the process even more protracted.

Since March this year, stability has returned after the banking turbulence, but warning lights are flashing elsewhere, and tensions in Russia could be another possible source of stress.

Here are a few pressure points.

1/ REAL ESTATE: PART 1

Just as hopes of an end to Federal Reserve interest rate hikes are supporting the U.S. housing market, European residential real estate is suffering from rising interest rates.

Rates in the UK have risen from 0.25% to 5% over the past two years and trade body UK Finance estimates that around 2.4 million homeowners will move from cheap fixed interest rates to much higher rates by the end of 2024.

Sweden, where rates rose on Thursday, is one country to watch as most homeowner mortgages move along with rates.

Richard Portes, professor of economics at London Business School, said eurozone housing markets appear to be “freezing up” as transactions and prices fall. “In 2024 you can expect even worse consequences of higher interest rates,” he said.

2/ REAL ESTATE: PART 2

Commercial real estate, having taken advantage of the era of low rates to borrow a lot and buy property, is struggling with the rising costs of refinancing debt when rates rise.

“The most important thing is interest rates. But not just interest rates; the predictability of rates is also important,” said Thomas Mundy, head of South American capital markets strategy at real estate firm JLL. “If we solved the interest rate issue, real estate prices could adjust. But as it stands now, the delay in adjusting real estate prices is creating uncertainty.”

In Sweden, high levels of debt, rising interest rates and a falling economy have created a toxic combination for commercial real estate. And HSBC's decision to leave the Canary Islands in London in favor of a smaller office in the City highlights the trend toward smaller office space that is sweeping commercial real estate markets.

3/ BANK ASSETS

Banks remain in the spotlight amid a squeeze on credit conditions.

“There is no place of refuge from these tighter financial conditions.

Banks have two types of assets on their balance sheets: those that are for liquidity and those that work as value-added savings. Rising interest rates have reduced the value of many of these assets by 10-15% from their purchase price, Yelpo said. If banks have to sell them, there will be unrealized losses.

Banks' real estate assets are the most vulnerable. Federal Reserve Chairman Jerome Powell says the Federal Reserve is closely monitoring banks to address potential vulnerabilities.

Credit standards for ordinary households are also a problem. Yelpo expects consumers to stop repaying loans in the third and fourth quarters.

“This will become the Achilles' heel of the banking sector,” he added.

4/ DEFOLT.

Rising interest rates hit companies as the cost of their debt rises.

S&P expects the default rate for European companies with lower investment grade ratings to rise from 2.8% in March 2023 to 3.6% in March 2024.

Markus Allenspach, head of fixed income research at Julius Baer, notes that in the first five months of 2023, the number of defaults globally was the same as in all of 2022.

French retailer Casino is in debt restructuring talks with creditors. Sweden's SBB has been struggling to survive since its shares plunged in May due to concerns about its financial situation.

“We're starting to see increasing problems in the corporate sector, especially in the low-end segment, which has the most floating rate debt,” said Nick Kremer of S&P Global Ratings.

5/ RUSSIA AFTER WAGNER'S THROWING.

Wagner's flailing, the most serious threat to Vladimir Putin's rule, may be interrupted, but its effects will be felt for a long time. Any change in Russia's position - or in the momentum of the war in Ukraine - could be felt near and far.

There are direct implications for commodity markets from oil to grain, which are the most sensitive to domestic developments in Russia. And the indirect effects, from pressure on inflation to risk aversion in the event of a significant escalation, could have far-reaching consequences for countries and companies already feeling the pressure from higher rates.

“Putin can no longer claim to be the guarantor of stability in Russia, and this kind of fragmentation and challenge to the system is impossible in a stable and popular regime,” said Tina Fordham, geopolitical strategist and founder of Fordham Global Foresight.