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The end of free money

Starting last November, interest rates have moved straight up, led by the US. From record-low interest-rate levels, this yield reset has triggered the worst bond market rout since bond returns have been recorded. The end of free money has, in turn, triggered a repricing of all risk assets across the entire spectrum. Discover our #CIOViews and watch our recent webcast below.




As discussed in our recent Beyond Markets webcast, markets are tricky to navigate these days, to say the least. Both bonds and equities experienced record-breaking worst first trimesters, and even the niches where investors could shield themselves just a couple of weeks ago, namely commodities and energy companies, have not been of great help of late.

Facing changes
The financial world is in the midst of a painful and unfamiliar transition. After a decade characterised by ultra-low interest rates and what seemed like ‘quantitative easing (QE) forever’, we are finally seeing a credible tightening cycle from the US Federal Reserve (Fed). It is the beginning of the end of the ‘free money’ era.

Note: The Bloomberg Global Aggregate Bond Index is a flagship measure of global investment-grade debt from 24 local currency markets. This multi-currency benchmark includes treasury, government-related, corporate, and securitised fixed-rate bonds from both developed and emerging-market issuers. The chart displays the range of annual total returns (unhedged, in USD, using daily data) for the years 2000–2021 (shaded area), as well as the year-to-date total return for 2022 up until May 9 (blue line).

Impact of war in Europe
What separates this attempt to end financial repression from the others in the past is that we are operating in a ‘post-invasion of Ukraine’ world.

The Russian invasion of Ukraine has sent shockwaves throughout the West, shining a light on its inconvenient dependence on countries that may not always be reliable partners. Going forward, Western governments will work to onshore their energy, technology, manufacturing, and defence supply chains, accelerating the reversal in globalisation.

Crucially, both the US and Europe face real-world capability constraints to onshore production.

Yves Bonzon, Group Chief Investment Officer

This, in turn, for the first time since the Global Financial Crisis (GFC), has the potential to revive domestic investment and jump-start private credit demand. This means that, paradoxically, a policy mistake is much less likely today than before 24 February 2022, and the Fed indeed has more room to tighten.

We are, however, not as bold as the current consensus with our expectations of rate hikes. Crucially, both the US and Europe face real-world capability constraints to onshore production. The acquisition of new expertise and know-how in sectors that have sometimes been neglected or abandoned (e.g. semiconductors or nuclear energy) is not an overnight affair, and the switch from foreign to domestic suppliers will take time.

Ultimately, the transition timeline does not allow for a full return of high interest rates this time around, but the prospect is definitely in the cards for future cycles.

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