31 Aug 2020 2 min

Fed changes gear

On 27 August 2020, Federal Reserve Governor Jerome Powell decided to remove the 2% monetary policy constraint on inflation, giving priority to employment and economic growth.

Powell did not explain in detail which expansionary instruments will be used, but he clearly said that nothing will be the same. Inflation will grow, but employment and wages will grow, as will GDP and other real variables. This is an explicit endorsement of Trump's economic programme, i.e. negative real rates to stimulate investment and domestic demand to reduce the trade deficit, a very different policy than in the past, when the US relied on an internationally accepted dollar to export trade deficits.

The consequences of this decision are significant, starting with the credit market. Indeed, it is reasonable to expect that chip loans will receive a return below the rate of inflation and this will erode capital to the benefit of borrowers, causing a transfer of wealth from financial rents to industrial profits.

The two main asset classes penalised by this manoeuvre are therefore cash and investments in bonds, especially government bonds. On this basis, the dollar is set to continue its weakening trend against the euro and other major international currencies.

The sectors that will benefit are first and foremost commodities and precious metals, since the opportunity cost of holding non-dividend paying assets will be substantially zero. Moreover, since the expected inflation premium is unlikely to be factored into market rates, gold and precious metals will play an important role as a store of value.

Equity investment can also benefit from the Fed's new monetary policy, but with a different perspective depending on the sector.

Regardless of how the ECB reacts, such a scenario will also affect European investors, who will be increasingly faced with the choice between the stock market and commodities.

Study Centre - Hetica Capital