A narrow path

In recent weeks and months, the US Federal Reserve (Fed) has sharply adjusted its monetary policy communication. From the original demonstrative composure regarding the reduction of stimulus measures and an initial increase in key interest rates, the pendulum has swung in the other direction at virtually the speed of light. Now it seems that the US monetary watchdogs would have preferred to end quantitative easing yesterday rather than today and start the cycle of interest rate hikes. Moreover, the Fed is already thinking very loudly about a roadmap to reduce its own balance sheet. Although monetary policy in the US must still be considered expansionary by historical standards, Federal Reserve Chairman Jerome Powell is taking a very “hawkish” stance in the meantime. The current high inflation, a labor market close to full employment and very attractive financing conditions seem to justify this stance. Given the ongoing risks regarding the corona pandemic or supply chain issues, the US central bank is currently walking a fine line, so to speak.?

Financing conditions in the US remain attractive

Despite the change in the Fed's rhetoric, financing conditions in the United States have remained attractive and very expansionary (graph 1). With economic growth above potential levels and consumers having accumulated more than USD 2.5 trillion in savings since the start of the corona crisis, the situation is definitely becoming more challenging for the Fed.

The risk of a “monetary policy mistake” has clearly increased in recent weeks. On the one hand, Fed Chairman Powell knows that structural inflationary pressures have increased, but consumer sentiment is at a ten-year low despite the current high savings rate. On the other hand, the Fed is also aware that raising rates too quickly, combined with balance sheet reduction, could lead to enormous downward pressure on equity markets. Powell already experienced this once in the fourth quarter of 2018 – after a classic communication error.?

Policy accommodation increases short term volatility

Investor expectations are often more decisive than the effective actions of a central bank. Capital markets have already discounted four rate hikes in the current year and another two to three steps of 25 basis points each in the following year. In the past, it has often been shown that the announcement of initial interest rate steps exerts much more pressure on the markets than when the steps are then actually implemented. We believe that the financial markets have already priced in a large part of the QE reduction and interest rate steps over the next 18 months, as well as the start of the balance sheet reduction (QT). Nevertheless, investors should be prepared for some volatility in the coming weeks, in our view. In addition, the corporate earnings season that has just started will be the first real litmus test for many companies in the new monetary policy environment.?

Barbell mix as a success factor

In the current environment of a changing monetary policy of the world's most important central bank and at the beginning of the reporting season, the right mix remains central to our investment strategy. In addition to higher volatility and lower expected returns, we believe that a “barbell mix” is currently a success factor. On the one hand, the portfolio should be selectively stocked with long-term return drivers such as equities. On the other hand, we consider asset insurance such as gold or other “real” assets to be indispensable in today's setup.