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Due to the long-term insistence that inflation is temporary, the Fed’s response to inflation is too late. As far as policy is concerned, it still lags behind the level it needs to achieve. What the market needs is to gradually reduce cash inflows.
The current environment is very important. If you are in a deflationary environment, you can stay accommodative longer and work hard to improve everyone’s living standards. This makes sense. However, when you are facing a global inflation environment and you are trying to improve everyone’s standard of living, it is very difficult.
What you have to do in the end is to hit the most vulnerable groups in society twice. You first hit the disadvantaged through inflation. At present, the prices of bulk commodities have begun to rise. The most vulnerable parts of society will be hit by the decline in economic activity, and there will be unemployment.
When the inflation rate rises, people tend to spend a larger proportion of their income on basic necessities. We have seen food and natural gas prices rise. Another method the Fed can try is to raise interest rates and try to shrink its balance sheet. This achieves a sustainable path. There is an old saying that macro stability is not everything; however, if there is no macro stability, you have very little.
Macroscopic stability is a necessary condition. The policy response should be for the Fed to speed up, let go of the throttle, and raise interest rates. Then we need to take action to increase labor participation and increase labor productivity. More work is needed to understand and supervise the non-bank financial sector. This can be repaired. It just needs to be properly implemented.
The most accurate forecasts currently cannot help us predict that the 10-year yield will end this year. There has been a massive decoupling. The economy is not important to financial markets. What really matters to financial markets is liquidity injection.
If in 2021, your investment strategy is that liquidity rates will continue to be maintained, then you are doing the right thing. You are likely to do well in the market. Last year and the year before, it has been about liquidity. It doesn’t matter what the economy does or what the credit risk does. As long as your liquidity calls are correct, you will perform well in the market and make money. Therefore, for the time being, the best way is to tactically ride the wave of liquidity.
Nevertheless, the time will come when you have to move from liquidity issues to more basic issues. It is likely that in 2022, we will see it play a role. The current inflation dynamics are underestimated. Who would believe that the inflation rate in the United States is 6.8%, and the 10-year inflation rate will be around 1.50, a 30-year record high? So, the biggest question is whether this will continue into the new year.
Similarly, bonds have a supply and demand part, and if it is incorrect, it will appear in the picture. The Ministry of Finance borrows money to offset the deficit because it cannot produce currency, so the Ministry of Finance needs to sell bonds. If they don’t have enough bond buyers, problems will arise.
The Federal Reserve will step in and print money to buy the pond. At present, the world has overinvested in US dollar-denominated bonds, and their actual returns are negative, and the actual returns on cash are also negative. Therefore, if there is a sell-off and shift to other assets (such as stocks, commodities, and other assets (such as real estate, etc.)), this will worsen the balance of supply and demand.
Bank of America noticed how many times inflation was mentioned in its note, and this has become more frequent. A lot of attention is focused on inflation in the United States.
Inflation is in the minds of analysts and the Federal Reserve. Almost everyone thought of this, especially investors. The question that investors are most concerned about is how serious will the inflation problem be in 2022? And the reaction of the first person to read the Fed’s reaction to this, and the market’s response to the Fed’s intervention.
For example, what happens when you change today’s portfolio allocation based on the Fed’s actions or interest rate hike expectations and expectations. We expect the Fed to raise interest rates sometime this year. We hope that they will adopt a firm attitude in communicating and dealing with economic issues.
Therefore, this year is a year when the stock market may be more volatile. The total return on government bonds and corporate bonds may be negative for a year. Therefore, we see better opportunities elsewhere in the market. For example, credit markets or high-yield corporate bonds.
Analysts expect interest rates to be hit. This interest rate cycle may be different because in the past 10 to 20 years, the Fed has been focusing on unemployment.
So, what they have been doing is raising interest rates until they start to see pressure on the job market. This time it may be very different, because the Fed cares less about the labor market and more about fighting inflation.
What investors need to do is to start evaluating their investment portfolios in advance to prepare for rising interest rates. Position your investment portfolio before raising interest rates and keep available cash to take advantage of market adjustments. This may be the best way to deal with what may be an unusual year.
There is a lot of debate on Wall Street as to where the Fed’s attention is now and the extent of the market sell-off before the Fed takes action. Therefore, investors need to be prepared to allocate funds from the part of the Fed-sensitive market to other areas of opportunity, and be prepared to deploy funds if the Fed is too tough and leads to market adjustments.
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