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Inflation and interest rates: how to plan your investments?

Inflation and interest rates: how to plan your investments?

This month, the entity accelerated its monetary normalization process and raised interest rates by 50 basis points, the most significant increase in twenty years. We expect the rate to continue correcting upwards, a process that should not stop until such time as there is a significant slowdown in the inflation rate.

In this environment of rising interest rates, The risk of an economic recession in the US grows. As we mentioned, the central bank of that country privileges containing inflationary pressures over the cycle of economic recovery.

In this way, the market begins to incorporate a climate of greater monetary restriction, with a special impact on risk assets. In effect, variable income assets have been suffering a significant contraction.

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It is worth emphasizing that the high inflation scenario is far from the usual when defining a portfolio. In episodes of nominal stability, a position in fixed income would normally have acted as a counterweight or hedge against the risk of a fall in shares. In this case, however, we observe that the correlation between both types of assets becomes positive in environments of high inflation.

That is to say that the bonds no longer protect the portfolio in scenarios of correction of actions. This was already registered in the performance of fixed income in this 2022, where investment grade, Treasury and high yield bonds all showed contractions, in line with the stock indices.

In a context of high inflation, it tends to favor a position in inflation-adjusted bonds, gold, commodities and emerging currencies, as well as energy assets.

The inversion of the yield curve in the US can be interpreted as a signal from the bond market that an economic recession is coming, a fact that happened briefly during the month of April and was quickly corrected.

In this context where the Federal Reserve tightens monetary policy, the question for the market is whether this leads to a recession or a “soft landing” of economic activity. To the extent that the recession is a distant event, equities could deliver better returns than fixed income. As we get closer to the recession event, this trend reverses.

Historic returns by asset type on the eve of an economic recession in the US.

Asset Management Director of Criteria

Source: Ambito

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