Four years have passed since the outbreak of the pandemic Covid-19. And, although in many aspects the pandemic It is already part of the past, there are still certaineconomic blows.
The strict quarantines generated an abrupt drop in economic activity, which, in magnitude, exceeded the Global Financial Crisis (2008) or any other recession seen in the United States since the Great Depression (1929).
To prevent these declines from evolving from transitory to permanent, governments promoted fiscal stimulus packages while Central Banks carried out expansive monetary policies. Specifically, in In the United States, 3 fiscal packages were approved for a total of 25% of GDPwhile the FED once again brought the monetary policy rate to the range between 0% and 0.25% YTM – known as ZIRP or Zero Interest Rate Policy – and a new Quantitative Easing -the QE4 which, in magnitude, almost doubled the previous three combined.
We could say that the economies experienced a strong recovery in “V” shape thank you, in part, to the rapid and forceful response of the various governments and Central Banks. Today, four years after the start of the pandemic, almost all the main countries in the world show economic growth compared to the levels seen in December 2019, but everything in the economy has a cost.
In mid-2021 one of those costs began to manifest: inflation. In June 2021, year-on-year CPI inflation stood at 5%. One year later, year-on-year inflation ICC in the United States was located at 9%, the highest value since the beginning of the 1980s. This phenomenon was repeated in the vast majority of developed and emerging countries with the rates of inflation highest in the last 30 or 40 years -excepting, mainly, those countries that were already showing inflationary problems prior to the pandemic-.
At that time, discussions revolved around whether the inflationary rise was temporary or if there were characteristics that would give it some persistence. In light of the results, one could affirm that the discussion was won by those who saw greater persistence because even today, 2 years after those maximums, we are seeing that in the United States inflation is above the Federal Reserve’s objective – the year-on-year inflation PCE Core February stood at 2.8%, while the target of the FED is 2.0% – and accelerating slightly.
Just as the Central Banks responded with expansive monetary policies when the pandemic began, they had to start a new cycle of rate hikes to counteract the rise in inflation. And like everything observed post-pandemic, the movements were among the most abrupt in a long time. For example, the Federal Reserve raised the monetary policy rate range by 525 bps in 16 months, the fastest rate increase in the last 40 years.
As a consequence of this rapid rise in rates and high valuations, financial assets had one of the worst years in their history in terms of returns. The typical 60/40 investment portfolio (portfolio that invests 60% of its assets in stocks and 40% in Fixed rent) had its worst performance in the last 60 years in the United States (last data record for comparison).
The pandemic, for better or worse, synchronized economic cycles globally. And although divergences are observed today in terms of economic growth – while the United States grew at rates of 4.9% and 3.2% annualized quarterly in the last two quarters of 2023, in Germany the growth was 0.0% and -1.1%, in Japan -3.1% and -1.1%, and in China 4.9% and 5.7% respectively -, the Central Banks, in terms of monetary policy, remain aligned. And the vast majority of them are in the process of beginning a path of normalization.
What does this normalization imply? Mainly two things. On the one hand, starting a new cycle of lowering rates to bring the reference rate towards the levels that the members of the Central Banks consider the long-term equilibrium range – in the case of the FED this implies bringing the rate to the range between 2.50% and 2.75% YTM-. On the other hand, continue with the so-called Quantitative Tightening which consists of shrinking the balance sheet to absorb part of the excess liquidity.
Although the FED is postponing the start of lowering rates – given that inflation is showing a slight acceleration and persistence -, its members are confident that said cycle will begin at some point in 2024. In that sense, the Central Bank of Switzerland -SNB or Swiss National Bank- was the first of the G10 Central Banks to begin lowering or “normalizing” its rate. Paradoxically, in the case of Japan and contrary to the other Central Banksnormalizing monetary policy implies raising the rate – a process that began in the last meeting where the Central Bank of Japan decided to raise the reference rate for the first time since 2007.
Today, after the strong cycle of global rate increases, Fixed Income in general once again offers returns that have not been seen for a long time. To cite an example, the Treasuries of the United States with a maturity of 10 years yield around 4.20% (YTM). These same instruments offered 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 a monetary policy cycle that on the horizon would begin a cycle of lower rates provide the Fixed rent of great relative attractiveness.
But the truth is that the United States economy is expanding at high rates, that we could be witnessing the beginning of a new productive revolution at the hands of artificial intelligence and that we are evidencing demographic changes – lower population growth and higher life expectancy – which, as several economic leaders have mentioned, globally, they could leave us with higher interest rates for longer.
For now, the Fixed rent has returned to the center of the scene and this is great news. It is because it improves the diversification attribute in investment portfolios. And because for those of us who are passionate about finances, it gives us much more space to explore and analyze.
CFA and Fund Manager of Schroders Argentina.
Source: Ambito
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