History shows that risky asset prices are heavily influenced by the interaction of economic growth and inflation. Financial assets react differently to periods of rising inflation, slowing inflation, rising economic activity and slowing economic activity. Put simply, there are essentially four types of macroeconomic environment; and each one has particularities. These are: Deflationary Expansion (rising economic activity combined with slow inflation), Inflationary Expansion (rising economic activity combined with high inflation), Deflationary Contraction (declining economic activity combined with low inflation), and Inflationary Contraction (declining economic activity combined with high inflation). Barring left-field external shocks (the specter of wars, viruses, political disruptions, geopolitical issues), the transition from one environment to another is normally associated with abrupted changes in monetary or fiscal policies. In other words, one must firstly determine in which quadrant we currently are in and secondly assess whether central banks will employ policies to change venues.
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By Hubert Marleau
By Hubert Marleau