Fed caught between various factors
Significant market movements expected
The fact that the US Federal Reserve will end its policy of low interest rates and raise interest rates in the face of inflation at a 40-year high is considered a foregone conclusion on the markets. Not if and when, but how much and how often are the questions that investors ask themselves in connection with an interest rate hike in the United States. However, the hedge fund Bridgewater Associates, which was founded by stock market expert Ray Dalio and is aimed primarily at institutional investors, recently warned against expecting a return to normality once the Fed has adjusted its monetary policy.
Fed will cause increased turbulence
According to Bridgewater, further fluctuations are imminent in the markets because investors underestimate both inflation and the US Federal Reserve, according to a report by the experts.
Thus, the hedge fund experts expect a “coming clash” between what will happen and what investors would expect. Against this backdrop, the analysts say there is potential for large market moves that make holding assets risky, the analysts said.
Specifically, market turmoil would result from investors underestimating both the strength and aggressiveness of inflation. “Because there is such a big difference between what is discounted and what we think is likely, we see the potential for large market moves, which of course implies significant risks to holding assets,” reads the world’s largest hedge fund’s 2022 outlook .
US Federal Reserve faces major challenges
According to Bridgewater, the US Federal Reserve is facing a difficult environment. Aggressive monetary tightening is usually the method of choice to combat rapid inflation. However, US currency holders have additional things to consider with COVID-19 and the ongoing risks of new variants. Therefore, there will “continue to be questions about the sustainability of the rising inflationary pressures and ongoing uncertainty about the impact of the pandemic on economic growth,” the hedge fund experts continue.
An adjustment of monetary policy is out of the question for Bridgewater, but it is unclear “how aggressively the political decision-makers will pull the levers,” says the annual outlook.
It’s also important to note that stock markets – particularly those in the US – may become more sensitive to interest rate hikes, the experts warn. “In terms of assets, high valuations and long maturities, driven in large part by low interest rates and ample liquidity, mean moderate tightening could be painful – particularly in the most bubbly segments of the US stock market,” they write.
Risks for investors ahead
Investors face two risks in this environment. On the one hand, assets could lose value in the face of persistently rising inflation. On the other hand, there is a risk that the US central banks will fall further behind inflation and have to catch up aggressively.
Markets, Bridgewater analysts say, are currently pricing in a smooth transition to non-inflationary growth without the need for aggressive tightening. Investors therefore do not believe that the Fed will have to make massive monetary policy adjustments, but on the other hand they probably do not see the risk of higher inflation either. However, this deviates significantly from what the Bridgewater analysts consider likely, the annual outlook continues. Therefore, the “potential for large market movements” is given.
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