The bar for rational policy making couldn’t get any lower, or could it?

First and foremost, inflation is becoming stickier, making monetary policy more constrictive and credit tighter. Even with the best of conditions, it’s difficult to see US inflation drop below 3% at the end of the year and UK inflation below 5%. Even if the Fed doesn’t hike rates in June, a likely event after this week’s comments by officials, the next move is still more likely to be a hike than it is to be a cut.

In the UK, investors now expect four further hikes before the end of the year, up from one a few weeks ago. Despite what’s being priced-in in bonds, it is very likely that we will not see easing of rates this year. Thus, barring a significant financial accident, investors should expect credit conditions to continue tightening for at least the next three quarters.

In light of tightening, all manner of risk could unfold.

With inflation this high, policy becomes uncertain. A couple of weeks ago, British Chancellor Jeremy Hunt said that he would be happy with a recession if it brought down inflation. This is a far cry from the pro-growth policies most investors have become accustomed to. And it is also diverging. The US, UK and EU outlook for monetary policy continues to decouple, adding an extra layer of difficultly for global asset allocators.

Shadow banks, organisations that essentially borrow and lend money without actually being banks, are coming to the spotlight. These shadow banks don’t enjoy the protections of central banks, so a liquidation event could have unforeseen repercussions.

Private Equities are also an emerging risk. Funds that built their existence on the ability to borrow cheaply, are now faced with potential losses as rates rise and valuations drop. Real valuations remain a mystery. Private companies won’t sell stakes at lower prices, to avoid losing their high valuations. They also can’t borrow as rates are high. Some of them will face existential dilemmas, as will their owners.

And so, it goes. Money remains expensive. With tight labour markets and relatively robust consumption we should expect it to remain so for the next year or so. Those organisations that relied too much on cheap money will find themselves facing a difficult future. This year’s investment theme is not to be bearish. It is to be very cautious and very selective. It is the year that doing your homework will pay off.

George Lagarias, Chief Economist