Normalizing the monetary policy cycle, what's next?

It has been four years since the outbreak of the epidemic Covid-19. Although it is in many aspects pandemic It has already become part of the past, and there is still certaintyEconomic strikes.

The strict quarantine led to a sudden decline in economic activity, which exceeded in magnitude The global financial crisis (2008) or any other recession the United States has experienced since then Big disappointment (1929).

To prevent these declines from developing from temporary to permanent, governments strengthened fiscal stimulus packages while central banks implemented expansionary monetary policies. Specifically, in In the United States, 3 financial packages were approved, totaling 25% of GDPwhile the Fed once again lowered the interest rate to a range between 0% and 0.25% since the beginning of the year – known as ZIRP or zero interest rate policy – and a new interest rate policy. Quantitative easing – The fourth round of quantitative easing, which has almost doubled in size than the previous three combined.

We can say that economies have witnessed a strong recovery in “V” shape Thank youThis is partly due to the rapid and strong response of various governments and central banks. Today, four years after the pandemic began, almost all of the world's major countries are showing economic growth compared to the levels they saw in December 2019, but everything in the economy comes at a cost.

In mid-2021, one of these costs began to emerge: Economic inflation. In June 2021, the year-on-year CPI inflation rate was 5%. One year later, it had swelled year-on-year International Criminal Court in the United States The inflation rate reached 9%, the highest value since the beginning of the eighties, and this phenomenon was repeated in the vast majority of developed and emerging countries, where rates reached Economic inflation The highest levels in the last 30 or 40 years – except in those countries that were already experiencing inflationary problems before the pandemic.

At that time there were debates about whether the inflationary rise was temporary or whether there were characteristics that gave it some continuity. In light of the results, one could argue that the debate was won by those who saw greater persistence because even today, two years after those caps, we see US inflation above the Fed's target – on an annual basis. – Annual inflation Basic PCE The February rate was 2.8%, while the target was Nourish it It is 2.0% – and is accelerating slightly.

Just as central banks responded with expansionary monetary policies when the pandemic began, they had to begin a new cycle of raising interest rates to counter rising inflation. Like everything observed after the pandemic, the moves were among the most surprising in a long time. For example, Federal Reserve It raised the monetary policy interest rate band by 525 basis points in 16 months, the fastest interest rate increase in the past 40 years.

As a result of this rapid rise in interest rates and high valuations, financial assets experienced one of the worst years in their history in terms of returns. typical 60/40 investment portfolio (A portfolio that invests 60% of its assets in stocks and 40% in stocks Fixed rent) had its worst performance in the past 60 years in the United States (the most recent data record for comparison).

The pandemic has, for better or worse, led to synchronized economic cycles globally. Although differences are noticeable today in terms of economic growth – while the United States grew at rates of 4.9% and 3.2% on a quarterly basis in the last two quarters of 2023, it Germany Growth was 0.0% and -1.1% in Japan -3.1% and -1.1%, and in China 4.9% and 5.7% respectively – Central banks remain consistent on monetary policy. The vast majority of them are in the process of starting the path to normalization.

What does this normalization mean? Basically two things. On the one hand, starting a new cycle of interest rate cuts to bring the reference rate towards levels that members of central banks consider to be the long-term equilibrium range – in the case of the Fed, this implies raising the rate to the range between 2.50% and 2.75% until the end of the year. On the other hand, communicate with the so-called Quantitative tightening Which consists of reducing the balance sheet to absorb part of the excess liquidity.

Although the Fed is postponing the start of interest rate cuts – given that inflation shows a slight acceleration and persistence – its members are confident that the said cycle will begin sometime in 2024. In this sense, the Swiss central bank – the Swiss National Bank or the Bank The Swiss central bank – the Swiss National Bank – was the first of the G10 central banks to begin lowering or “normalizing” the interest rate. Ironically, In the case of Japan, unlike other central banksNormalization of monetary policy implies raising interest rates – a process that began at the last meeting when the Bank of Japan decided to raise its benchmark interest rate for the first time since 2007.

Today, after a strong cycle of global interest rate increases, fixed income in general is once again offering returns not seen in a long time. For example but not limited to, Treasury bonds From the US with a maturity of 10 years the yield is about 4.20% (YTM). These same instruments provided returns between 2018 and 2019 that ranged between 2.0% and 3.2% (YTM). Furthermore, in October 2023, the yield on these securities was above 5.0% (YTM), the highest level since 2007.

These yield levels combined with the monetary policy cycle that will begin on the horizon provide a cycle of lower interest rates Fixed rent It has great relative attractiveness.

But the truth is that United States economy is expanding at high rates, that we could be witnessing the beginning of a new productivity revolution at the hands of artificial intelligence, and that we are seeing demographic changes – declining population growth and rising life expectancy – which, as many economic leaders have mentioned, globally could leave us with lower interest rates. higher for longer.

for now, Fixed rent He's back at the center of the scene and that's great news. This is because it improves the diversification feature of investment portfolios. And because for those of us who are passionate about financial matters, it gives us much more room for exploration and analysis.

CFA and Schroders Argentina Fund Manager.