Investors’ focus has been on rate hikes this year, but are they focussing on the right thing?

There is little doubt that rates are important.

A rapid rise, for example, in interest rates can exert pressure on companies and households who need to make interest payments on their loans.

Rates, however, are unlikely to be hiked aggressively given muted inflationary pressures; these are being supressed by globalisation and technology. In the US, ageing demographics and falling productivity are also helping to keep inflationary pressures under control.

Against this background, the fear that rising rates will stymie the recovery, seems unfounded. With real yields at -0.51%, interest rates will need to rise much higher to push real yields to 2.5%, which historically have preceded US recessions.

While the rise in interest rates is important, it has been discounted in large measure. Coming onto the radar, and so far largely unrecognised, is the volume of money.

It is important to recognise, that the full impact of the Fed’s reversal of its quantitative program will only be felt in the coming six months; so far in 2018, the Fed’s tapering has been close to guidance. It is about to be notched up as tapering swings into full action.

While global liquidity should be sufficient to fuel economic growth, “excess” liquidity which has been flowing into the financial markets will start to fall. Given that this “excess” liquidity has been suppressing the volatility in the financial markets – investors will need to brace for higher volatility going forward.

With the decline in “excess” liquidity, the rallies in momentum and growth focused strategies have already faltered while dividend and value-focused strategies have already started to make, albeit limited, headways.

Are we at the cusp of a big rotation in sectors and styles? Some of the catalysts are clearly in place.

Read more in our 2018 Mid Year outlook article “It’s time for a strategy shift”.