With inflation finally abating and real yields on Treasury bills showing signs of positivity, we find ourselves at a crucial crossroads in the financial landscape. Recent data indicates that inflation, which soared to a decade-high of 9.06% in June 2022, has been on a steady decline, sitting at 2.97% as of June 30, 2023. As investors and economists breathe a collective sigh of relief, this trend heralds a shift in the investment landscape that warrants careful exploration.
The trajectory of inflation over the past year paints a stark picture. After peaking at 9.06% in June 2022, we saw a steady decrease, albeit with a few bumpy patches. By the close of 2022, inflation had already eased to 6.45%, a promising sign. The months that followed witnessed an acceleration of this trend, culminating in May 2023 with a drop to 4.05% followed by a further decrease to sub-3% levels in June 2023.
As inflation subsides, an often overlooked but critical dynamic comes into play - the role of real yields on Treasury bills. As of now, the 6-month Treasury bill boasts a yield of 5.25%, a rare positive real yield in a context where inflation rates have been higher than short-term interest rates. This scenario may potentially draw investments out of the stock market, leading to a phase of de-risking among investors.
One critical impact of this shift towards Treasury bills is the potential for disintermediation of bank deposits. As funds flow from deposits to Treasury bills, banks could see a reduction in their source of easy and cheap capital. This process could further cool down the economy, as banks may become more selective in their lending practices, thereby slowing down the velocity of money.
This interplay of subsiding inflation, positive real yields on Treasury bills, and potential banking disintermediation suggests a slow-down in the overheated economy. While this might seem alarming on the surface, it is part of the natural ebb and flow of economic cycles. A slower, more sustainable rate of economic growth is healthier in the long run, as it reduces the risk of boom-bust cycles.
Investors would do well to consider this changing landscape. While the prospect of lower returns from equities may not be appealing, the security and predictability of Treasury bills are highly desirable in volatile times. Furthermore, diversified portfolios that balance higher-risk assets with safe investments like Treasury bills can optimize returns while minimizing risk exposure.
In conclusion, the subsiding inflation and the resultant shift in the financial landscape are not cause for alarm but instead present new opportunities for savvy investors. As we transition from a high inflation environment to one with lower inflation and positive real yields on Treasury bills, investors must adapt their strategies to thrive in this new economic climate. By keeping a keen eye on these shifts and adjusting accordingly, we can navigate this transition effectively and profitably.