Instead, the successive confinements should have caused a drop in the price of services. But that did not happen.
In fact, the deficit in demand for services is largely due to changes in behavior, which cannot be corrected with lower prices. If someone does not go to the movies or does not take a plane because they are afraid of catching Covid-19, lowering prices will not encourage them to do so. Families may even interpret falling prices as a sign of increased risk, increasing aversion. In technical terms, the elasticity of demand for certain services has been reversed.
This is a major problem for central banks, because if the price elasticity of demand for services has changed, then the increase in aggregate inflation is no longer a reliable indicator of the increase in aggregate demand. Hence Investors may fear a monetary policy error on the part of central banks.
Either due to a tightening that is too fast that interrupts growth, or due to a behavior that is too expectant, also known as “going behind the curve”, which favors secondary effects (wage increases, upward revision of the expectations of families and investors, etc.) and a more inflationary change of framework.
Today, investors still prefer the thesis of temporary inflation or rather a return to secular stagnation. The 30-year US Treasury bond rate at 1.70%, with annual inflation of 6.2% and GDP growth of 5.5% by 2021, is a perfect reflection of the financial repression led by the central banks, but also a return to limited growth potential.
In that case, we must continue to focus on quality and growth actions.
Let’s take a closer look at the best scenario, in which Covid goes from pandemic to endemic in 2022, clearing the way towards a normalization of monetary policies. However, central banks will have to be flexible in reducing their purchasing program and in their rate hike schedule. Indeed, a too strong rise in interest rates would raise the burden of public debt, further aggravating fiscal deficits.
If we were to classify Risks in descending order across all asset classes, US long-term rates would lead.
Indeed, if the interest rate on 30-year US Treasuries rises to 2.50% (from the current level of 1.70%), that is, the level of March 2021, and Considering a duration of 22.8, the profitability would be -18% (0.8% x 22.8), all other things being equal.
In such an environment, driven by solid growth, asset classes capable of limiting the erosion of capital caused by inflation must be favored, including listed shares and venture capital (private equity).
Meanwhile, the trajectory of the US dollar will shape the future performance of regional assets. If the dollar falls, Europe and emerging markets should be favored. If the dollar continues to rise, the United States is likely to offer the best returns again.