As the recovery continues, markets will begin to adjust to “tighter” monetary conditions, a process that will likely bring volatility but will also present opportunities.

The FOMC left the target range for the federal funds rate unchanged at 0–0.25% at its December meeting.Citing high inflationary pressures and further improvement in the labor market, the Committee announced that it would double the pace of tapering to $30 billion per month in January. The dot plot showed a baseline of 3 rate hikes in 2022, 3 hikes in 2023, and 2 hikes in 2024—a “heavier” pace, but less steep than expected. Two-thirds of participants projected three or more hikes next year—an aggressive move— but most participants did not foresee a restrictive policy over the forecast horizon. As expected, the statement removed any reference to transitory factors in its characterization of inflation and instead noted that supply and demand imbalances “continued to contribute to elevated levels of inflation.”

There were three substantial revisions to the FOMC statement: ( 1) no longer characterizing inflation as transitory, (2) identifying the new variants as a risk, and (3) updating the forward guidance to remove the reference to inflation below 2 percent and adding that achieving full employment is the final hurdle before the rate hike cycle begins. Overall, the short-term signal regarding policy intentions was in line with expectations, indicating that a rate hike is likely sometime during the second and third quarters of 2022 (in this regard, we believe a rate hike in June is the most likely scenario).

When looking at the economic and interest rate projections, there are a couple of things that we believe are relevant in terms of their impact on the various asset classes and our projections for 2022.

• The most obvious point—and one that is consistent with what we’ve discussed in other newsletters—is that 2022 will continue to be a year of higher (but controlled) inflation, but also of stronger economic growth, which is not consistent with fears of stagflation. This has significant implications for the market. A stagflation portfolio should be overweight in commodities, neutral in stocks, and underweight in bonds. In contrast, a more inflation-focused portfolio should be overweight in commodities and stocks and underweight in bonds in a more aggressive manner.
• Second, beyond the “more aggressive” tone in the short term, most participants did not forecast a restrictive policy over the forecast horizon , and we believe that monetary policy will remain supportive through 2022, given that the policy rate would remain “accommodative” in real terms.

In this context, we continue to believe that 2022 will be the year of a full global recovery and the end of the global pandemic, thanks to widespread population immunity and new therapies. We believe this will lead to a strong cyclical recovery, a return to global mobility, and the release of pent-up demand from consumers (e.g., travel, services) and corporations (inventory restocking, capital investments, and share buybacks), against a backdrop of continued accommodative monetary policy.

For this reason, we remain positive on stocks, commodities, and emerging markets, and negative on bonds.We expect cyclical and value assets to outperform, riskier and more volatile assets to recover, and headwinds for defensive sectors and market segments that benefited from the pandemic. As the recovery continues, markets will begin to adjust to tighter monetary conditions, a process that is likely to bring volatility.

What is the main risk to our outlook? The uncertainty surrounding high inflation and the normalization of monetary policy.

Humberto Mora

Strategy and Investments