The Global Regime Shift Towards Higher Interest Rates and Less Liquidity: What It Means for Businesses

As global central banks shift towards higher interest rates and less liquidity, businesses must adapt to significant investment and resource allocation transformations. This ongoing regime shift and structural inflation pressures will limit central bank intervention in extending expansions and shortening recessions.

The Business Cycle

The business cycle is an overall state of the economy that progresses through four stages: expansion, peak, contraction, and trough. Each stage is characterized by gross domestic product (GDP), interest rates, employment, and consumer spending. For example, during the expansion phase, economic activity increases, consumer spending rises, employment levels rise, and inflation rises. In contrast, during the recession/contraction phase, economic activity declines, consumer spending decreases, unemployment levels increase, and inflation falls.

Central banks use monetary policy to impact the business cycle by controlling the supply of money and credit in the economy. In addition, by adjusting interest rates and deploying other monetary tools, such as quantitative easing (QE) or tightening (QT), central banks can influence economic activity and help maintain stability during different cycles.

Cyclical or Structural Inflation?

Cyclical inflation is caused by fluctuations in the business cycle and is generally temporary. Central banks often use monetary policy tools like interest rate adjustments to reverse cyclical inflation. On the other hand, structural inflation refers to inflation caused by long-term factors built into an economy, such as supply and demand imbalances, deglobalization, demographics, and decarbonization. Structural inflation is persistent and difficult to counteract, often requiring fundamental economic changes to address it.

In 2022, the height of the COVID-19 pandemic led to supply chain ruptures and disruptions that affected the entire world. Companies had to reconstruct these supply chains, often bringing them closer to home, leading to higher labor and energy costs shortly and likely resulting in structural inflation. This was also anticipated due to the decline in labor’s share of national income (the portion of GDP paid out in wages, salaries, and benefits), which has decreased in developed economies since the 1980s. As a result, higher returns to labor versus capital in the short-term are expected.

Disruptions and Opportunities

Disruptions have created several opportunities for active fixed-income management. The dramatic interest rate increase in 2022 illustrated this. The current regime shift will lead to more such opportunities. Volatile business cycles will result in transformations in business investment and resource allocation. In such times, adapting and investing in areas that will provide better long-term returns is vital.

Related Facts

• The global economy has experienced significant disruptions recently, including the COVID-19 pandemic, supply chain ruptures, and changes in trade policies.
• Structural inflation is persistent, difficult to counteract, and requires fundamental economic changes.
• Companies have had to reconstruct their supply chains, often bringing them closer to home, leading to higher labor and energy costs in the future.

Key Takeaway

The ongoing regime shift towards higher interest rates and less liquidity will significantly affect businesses. Understanding the business cycle, cyclical versus structural inflation, and opportunities that arise during volatile times is crucial for success. In addition, adaptation and investment in the right areas for long-term returns are critical to navigating these changes.

Conclusion

In conclusion, the ongoing regime shift towards higher interest rates and less liquidity will significantly change business investment and resource allocation. Structural inflation pressures, driven by labor and energy costs, will make it difficult for central banks to intervene as they have in the past. Adaptation and investment in the right areas will be crucial during disruption and transformation.