WILL INFLATION BE FOLLOWED BY RECESSION?

Hardly any other economic topic is currently the subject of such heated debate as the impact of inflation. Reports of new highs are constantly coming in, increasing the pressure on the central banks. Solutions are required that do justice to both the upswing and the current challenges. Not an easy task in the current environment.

The last time the USA recorded an inflation rate of this magnitude (+8.5%) was over 40 years ago. In order to counteract this increase, many economists are currently assuming that the Fed will raise the reference interest rate by half a percentage point at each of its next meetings in early May and mid-June. Subsequently, the key interest rate would be back at 1.25% to 1.50% at the beginning of summer 2022. This is expected to rise to 2% by the end of the year, which would again correspond to the level of September 2019. A rapid rise in interest rates is also expected to have side effects, with recent forecasts seeing a correction in the equity markets and the risk of a recession in the coming months.

The eurozone is currently experiencing 7.5% inflation, but the ECB faces two fundamental challenges with its interest rate decisions: On the one hand, the EU comprises a community of different euro states, which are very heterogeneous in terms of how they are managed and whose inflation rates range between 4.6% and 15.6%. However, since even the lowest inflation rates are well above 2%, this point is currently receding into the background. The focus is on the second point, namely that a conceivable interest rate hike could have a negative impact on or restrict economic growth and, at least in some countries, stifle or even stall growth. The ECB is currently preparing to let the bond program of EUR 40 billion per month expire in the fall of 2022 before interest rates can be raised. The first rate hikes are forecast from 2023. It remains to be seen whether this timetable will have to be shortened as inflationary pressures continue to mount.

The Swiss economy has proven itself several times in recent years, recovering quickly from the challenges posed by rapid easing and with increased demand. The inflation rate of 2.4% is at a relatively low level compared to other countries and within reach of the targeted 2%.

When can we expect a recession?

A recession in the U.S.A. must be expected at the latest since the yields on short-term U.S. government bonds have exceeded those on longer-term bonds. The inflation-related interest rate hikes by the FED also contribute to the fact that the U.S. yield curve has meanwhile turned and become inverted. In the case of inverted yield curves, short-term maturities bear higher interest rates than long-term maturities. According to theory, the interest rate spread between the two-year and ten-year U.S. Treasury bond is a reliable economic indicator that forecasts a recession within two years. On average, there are 6 to 24 months between inversion and recession.

Some euro countries are also threatened by recession if, among other things, the geopolitical situation deteriorates further and further sanctions are imposed. An immediate halt to additional Russian energy sources cannot be cushioned immediately and will lead to unforeseeable consequences in terms of growth. Many of the Euro states have already spoken out in favor of an oil embargo and the EU Commission is working on a possible implementation. This has significantly increased the risk of an impending recession, especially for the countries of Germany and Italy.

What’s next for the Swiss real estate market?

The real estate market has already fully recovered from the Corona crisis in 2021 and property values are again showing record levels. Despite rising mortgage rates, demand continues to outstrip supply at present. The outlook for the future, on the other hand, has changed. Uncertainties regarding inflation, rising interest rates, economic risks and the further course of the Ukraine crisis have accentuated over the past few weeks, with a direct impact on values and yields in the Swiss real estate market. The factors that need to be taken into account when hedging interest rates can be read in the following article.

All indications are that the ongoing inflation will be fought with interest rate hikes. Mortgage rates have already risen on the long maturities and have pushed the yield curve up significantly in recent months. Rents and financing costs, or the underlying short-term bank refinancing rate (Saron), are likely to be at higher levels in the medium term than we have become accustomed to since 2015.

These factors have had an impact on the decade-long upward trend of the Swiss real estate market. The steady rise in property values has also caused debt capacity to skyrocket, and this at constantly low financing costs. Those who are liquid will have no problems with possible lower property values. Those that have taken on maximum debt will struggle with refinancing challenges as prices fall. However, the high level of debt in Switzerland will also mean that prices cannot fall too much.

If you are uncertain about the current market movements regarding your financing strategy, we are happy to offer you a modeling of different interest rate scenarios. In doing so, you can determine which interest rate scenarios should be simulated and which interest rate hedging ratios should be applied.

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