Antonio Del Vaso is an accomplished investment advisory professional with expertise in business strategy, project management and team leadership. He holds an Executive MBA from SDA Bocconi and has a strong track record in improving business performance and client satisfaction. His experience spans roles in business strategy consulting, and investment advisory services, private banking.
Through this article, Antonio Del Vaso, Head of Investment Advisory at Volksbank • South Tyrolean People's Bank, explores how the interplay of monetary and fiscal policies impacts bond and equity markets. He emphasises the importance of focusing on short—to medium-term bond yields amid rising rates while cautioning against long-term bonds due to inflation risks. Del Vaso also highlights opportunities in equity markets driven by fiscal expansion and declining interest rates, advocating for a balanced, agile investment approach that adapts to evolving economic conditions.
Anticipating Trends in the Bond Market
The U.S. economic context has demonstrated remarkable resilience in a tightening monetary policy cycle characterised by rising interest rates and the Federal Reserve's balance sheet contraction. This resilience can partly be attributed to the compensatory role played by expansive fiscal policies. When the Fed increases interest rates, it aims to moderate inf lation and excellent economic activity, countering potential overheating. However, suppose significant fiscal stimuli, such as increased government spending or tax cuts, accompany such restrictive monetary policies. In that case, these latter measures can mitigate the contractionary effects of the former.
This mix of monetary and fiscal policies can generate complex dynamics in the bond markets. Rising rates could make short-term government bonds more attractive, offering higher yields than in recent times. On the other hand, fiscal spending may fuel long-term inf lation expectations, negatively impacting the long-term government bond market, which becomes less attractive in high-inf lation environments.
In an economy positively responding to such policies, bond funds focused on medium- and short-term instruments may offer relative protection against rising rates. These funds tend to have a shorter duration, making them less sensitive to interest rate changes than those with long-term bonds. In an environment where the balance between expansive fiscal policies and monetary restrictions persists, careful duration management and precise credit selection become even more crucial.
At the same time, if fiscal expansion continues to fuel demand and thus inf lationary pressures, we might need to navigate the implications of a potentially steeper yield curve. It will be essential to remain agile and adapt investment strategies according to the evolving relationship between monetary and fiscal policies and their effects on the broader economy.
In evaluating bond market trends, we consider the current macroeconomic context characterised by a potential transition toward less restrictive monetary policies by central banks, counterbalanced by fiscal policies that have maintained some expansiveness. We anticipate that this balance could offer opportunities in rates, particularly in the medium- to short-term segment of the yield curve—up to 5 years—where expectations for the first interest rate cuts might create an improving yield environment.
Regarding the long end of the curve, we remain cautious due to the inf lationary risks stemming from reshoring and near-shoring policies that could exert longterm price pressures. Simultaneously, we consider the potential disinf lationary effects linked to developments in artificial intelligence, which could boost productivity and mitigate some structural inf lation. Additionally, we do not underestimate geopolitical risk factors, whose developments could introduce further market volatility and uncertainty.
Exploring Equity Market Scenarios
In a context where interest rates are likely to decline as a direct consequence of expansive monetary policies adopted by central banks, the investment environment for equities becomes particularly interesting. The prospect of falling interest rates implies a lower cost of capital, which encourages corporate investments and consumption and supports overall economic growth. This scenario increases, all else being equal, the Equity Risk Premium—the relative attractiveness of equity compared to bonds. This increase in the Equity Risk Premium indicates that in a declining interest rate environment, equity investments become relatively more attractive than bonds, pushing investors toward the stock market in search of higher returns. Consequently, both factors—the lower cost of capital and the increase in the Equity Risk Premium—point towards an increase in expected equity returns.
At the same time, expansive fiscal policies, which may include measures like tax cuts or increases in public spending, have the potential to stimulate the economy further. Unlike interest rate policies, which tend to have a more uniform effect on the economy, expansive fiscal policies can target specific sectors, offering targeted investment opportunities. Given the inf luence of expansive budgetary policies on particular sectors, investors can identify targeted growth opportunities in areas expected to benefit from such policies. This approach requires understanding macroeconomic dynamics and political directions, positioning investments in sectors expected to receive a direct boost.
Conversely, investment strategies might lean towards more defensive options in an environment where monetary policies become more restrictive with a potential increase in interest rates to combat inf lation. These strategies protect capital against market volatility by exploiting sectors less sensitive to economic cycles or investing in assets considered "safe havens." We believe this is not the current context. Still, the decision to focus on investments in specific sectors that might benefit from expansive fiscal policies or opt for a more defensive approach in response to a context of higher rates and restrictive monetary policies must ref lect a balance between the pursuit of growth and the need for investor protection, aligning return objectives with the appropriate risk and diversification profile.
In conclusion, the equity investment landscape is deeply inf luenced by the context of interest rates and monetary and fiscal policies. A deep understanding of these factors can guide investors in choosing between focusing on specific growth opportunities or adopting more cautious positions to preserve capital during economic uncertainty.
