Asset Allocation Update: The Interest Rate Shock Is Not Ending

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We continue to defend our “all-breaking” portfolio. The basic reasoning is that we are entering a new regime of higher interest rates – something investors haven’t faced in a decade. The constant talk of a “Fed pivot” should come as no surprise, as investors are unaccustomed to high rates. They have bought stocks, real estate and crypto over the past decade – all of which have benefited from low rates. But the economic reality has changed, inflation is rampant and central banks will probably end up raising rates more than expected. The Fed said so recently.

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We continue to defend our “all-breaking” portfolio. The basic reasoning is that we are entering a new regime of higher interest rates – something investors haven’t faced in a decade. The constant talk of a “Fed pivot” should come as no surprise, as investors are unaccustomed to high rates. They have bought stocks, real estate and crypto over the past decade – all of which have benefited from low rates. But the economic reality has changed, inflation is rampant and central banks will probably end up raising rates more than expected. The Fed said so recently.

What is the state of inflation? Well, looking at the consensus of economists, only Japan and Switzerland will experience average inflation of 2% or less in 2023 (Chart 2). Meanwhile, inflation in the UK and Spain is expected to be above 6%, inflation in Germany at 5.5% and inflation in the US at 4.5%. Against this backdrop, it’s hard to see why central banks would be willing to end their bullish cycles anytime soon.

In this context, we continue to favor the overweight in cash. This preserves his capital and is now starting to offer more attractive returns. Recall that at the beginning of 2022, the Fed’s key rate was 0.25% and today it is 4%. This means that all short-term interest rates should move accordingly. Interest earned on your bank deposit tends to be the last to move, but you can look for higher interest rates on short-term deposits. For reference, safe 3-month US government bills offer 4.1% interest, while slightly higher 3-month commercial paper rates are 4.4%. This means that one should be able to find savings products that offer interest around these levels. For the United Kingdom, the returns would be around 3% and for the euro zone, they would be around 1.5% (Chart 3).

Elsewhere, we think most assets will underperform, be it stocks, bonds, real estate or crypto. This is why we remain underweight or neutral on all these elements. The wild card is commodities – where we believe the medium term picture is bullish energy, but recession fears are short term bearish. For now, we remain neutral on commodities.

Finally, in terms of equity sectors, we like to be long in the energy, financials, healthcare sectors and short in the consumer and technology sectors. Our full list of industry views is available here.

Bilal Hafeez is the CEO and Editor-in-Chief of Macro Hive. He spent over twenty years doing research at major banks – JPMorgan, Deutsche Bank and Nomura, where he held various “global head” positions and researched currencies, rates and cross-markets.

(The commentary in the above article does not constitute an offer or solicitation, or a recommendation to implement or liquidate any investment or to engage in any other transaction. It should not be relied upon as the basis for any decision investment or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)

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