Dear Investors,
n this article you’ll find:
🎯 Higher long term inflation regime – (9 Regime Updates) Merrill Lynch
2% inflation target
Shift in monetary policy strategy
Longer term goals
Stock and bond correlation
🎯 Weaker US view is predicated – (3 US main points) Qatar National Bank
- One: the us economy is already slowing rapidly
- Second: investments are falling sharply
- Third: fiscal policy in the us is quickly turning from a tailwind into a headwind
Higher long term inflation regime – (9 Regime Updates) Merrill Lynch
2% Inflation target
The strong positive correlation between stock and bond returns as the Federal Reserve pivoted.
Financial conditions eased confirms the structural shift to a new higher long-term inflation regime.
For two decades, policy had fallen persistently short of its 2% inflation target, and the belief that the so-called “neutral” policy rate had declined in a new world of “excess savings.”
This lower-rate environment meant policy was more likely to encounter the “zero-rate” bound.
Making it harder to achieve the Fed’s goals of maximum employment and 2% inflation in downturns.
Shift in monetary policy strategy
Since this fundamental shift in monetary policy strategy, inflation has run closer to 5% on average than the 2% target for several years.
This raises the question of whether the Fed will continue this policy of deliberate inflation overshoots, or whether it will allow undershoots to offset them in a symmetric way that would restore the credibility of a 2% target.
Longer term goals
The markets are pricing in a continuation of the new, easier Fed policy after its recent pivot which has dramatically eased financial conditions over the past two months.
Market and academic commentators are increasingly suggesting the Fed’s target will be raised, perhaps at the next public monetary policy review.
Stock and bond correlation
During the low and falling inflation era prior to the pandemic, the correlation between stock and bond returns went negative.
This has giving rise to risk-parity strategies that used bonds which tended toward positive returns when stocks were falling.
In the low-inflation world, a higher risk of deflation and the zero-bound constraint on monetary policy made bonds a good hedge against a scenario where stocks would have negative returns.
This new normal is really a return to the old normal,
where inflation and interest rates run closer to their historical averages and the risk inflation breaks out to the upside as it did in the 1970s.
For investors, this means it’s more important to own real assets that tend to hold their value over time, as money loses its purchasing power.
Since World War II the purchasing power of the dollar today is worth less than a dime back then.
While the S&P 500 Index is back near its 2021 peak, its real value is considerably less because of the inflation since then.
Weaker US view is predicated – (3 US main points) Qatar National Bank
One: the us economy is already slowing rapidly
After an extraordinary GDP growth of 4.9% annualized in Q3 2023, the Atlanta Federal Reserve nowcast estimates a growth of only 2.0% for Q4.
This rare sudden deceleration suggests a rapid adjustment to a less benign macro environment.
Second: investments are falling sharply
After a period of ebullience, investments are falling sharply, with capital expenditure intentions now nearing negative territory.
This is led by a retrenchment from the private sector on the back of higher debt costs.
Third: fiscal policy in the us is quickly turning from a tailwind into a headwind
The US fiscal thrust, is set to decelerate from a positive 1.9% in 2023 to a negative 1.4% in 2024.
Hence, the US economy should slow down more than most analysts currently expect.
Entering into 2024, the view is slightly more bullish than consensus, as global economy expanding by 2.9%.
The global economy is set to remain lacklustre in 2024, growing below its long-term average.
All the three main economies (the US, Euro area and China) are expected to grow slower than their long-term averages.