“The risk of a policy error by the fed has increased considerably”

adminonJanuary 6, 2023February 19, 2023Leave a Comment

How much will the Federal Reserve raise interest rates? (Image: Shutterstock.com/Jim Vallee)

The market priced in probability of a 50 basis point move by the Fed as early as March shot up to nearly 86% in the wake of the latest inflation figures. It would be the first time in more than 20 years that the Fed has raised interest rates in one step by more than 25 basis points. This has significantly increased the risk of a policy error, says Martin Luck of BlackRock.

U.S. consumer price inflation rose to 7.5% in January, the highest in 40 years and once again higher than the December reading (7.0%) than the consensus had expected. "What weighed more heavily was the fact that inflation seems to be spreading from exclusively Covid-related components – such as so-called 'stay-at-home goods' – into various categories of the basket, including many services", says Martin Luck, Head of Capital Markets Strategy in Germany, Switzerland, Austria and Eastern Europe at BlackRock. The core inflation rate, from which the most volatile components energy and food are excluded, accelerated from 5.5% in December to 6.0% in January.

"It is probably this picture of spreading inflation, more than anything else, that has caused market participants to significantly tighten their expectations about the Fed's response", comments Luck further. In the wake of the inflation data release, the number of rate hikes priced into fed funds futures for this year had risen to more than six, and at its peak, nearly seven. This would mean that the Fed would shoot almost all its powder regarding the total expected interest rate steps (the majority of expectations regarding the 'terminal rate' are in the range of 1.75-2.0%) already this year.

Adding fuel to the fire

As the capital markets strategist goes on to point out, recently James Bullard, the governor of Federal Reserve St. Louis, who is a voting member of the crucial Federal Open Market Committee (FOMC) this year, adds fuel to that fire. In view of this high inflation data, Bullard says, he would like to be able to make up to 1. July to see 100 basis points of rate hikes bagged (quote: "I'd like to see a 100 basis points in the bag by July 1"). The market's priced-in probability of a 50 basis point move by the Fed as early as March then shot up, from 48% in the aftermath of the CPI numbers to nearly 86%.

"It would be the first time in over 20 years that the Fed has raised interest rates in one step by more than 25 basis points. Thus, the risk of a policy error has increased significantly. This is because such a rapid increase in refinancing costs would massively tighten financing conditions, especially in conjunction with the liquidity squeeze caused by the rapid expiry of bond purchases.", Luck points out and continues: "But these affect the demand side of the economy, investment and consumption, and thus such a tightening would mean a dampening of aggregate demand, with presumably noticeable consequences for growth and employment."

In the face of inflation, on the other hand, which is driven by the supply side (energy prices, bottlenecks in supply chains, etc.), the risk of a policy error on the part of the Fed is very high.), he believes that this would probably have little effect until demand-side prices, such as wages, begin to fall. "In other words: If a central bank really wants to break a supply-side price shock, it will have to slow down the economy drastically, even downright stall it", according to the capital market strategist. However, this does not seem to be the goal in view of the current economic situation, in which the central banks are presumably more concerned with normalizing monetary conditions after Covid – certainly not if one takes into account the new Fed strategy, which was only adopted in August 2020.

"In the big picture, this paints a picture of an FOMC that is feeling the pressure from the public in the face of extremely unpopular inflation trends and is starting to get very cold feet", Luck further comments. For markets, this increases the likelihood that some of the now priced-in six-plus rate hikes will disappear from fed funds futures by year-end. After the recent significant flattening of the yield curve, there are likely to be episodic market phases in which the curve steepened.

Puzzlement over Russia's course

In addition to the central banks, Russia's military buildup on the border with Ukraine is keeping the markets on tenterhooks. In the opinion of the capital market strategist, it is striking how differently the concrete risk of war is seen depending on where one looks. If Western experts on security and military strategy are to be believed, the likelihood of an attack has increased to over 70% with Russia's deployment of what is now probably a good 130,000 troops on the border with eastern Ukraine and from the north in Belarus. U.S. intelligence agencies are even said to have today, the 16. February, have identified as the day of entry. Western governments strongly advise compatriots to leave Ukraine. By contrast, analysts on the ground, i.e. in Ukraine itself and also in Russia, generally see the risk of war as considerably lower, at only 10%, and point to the immense damage of a war for all parties involved.

"The fact is that an actual escalation would also have massive consequences for the financial markets, from the risk-off of a war on European territory to dramatically rising energy prices and consequences for global trade. Should Russia's army actually invade Ukraine, whether before the end of the Winter Olympics or only afterwards, this could make the difference for stock investors for 2022 as a whole. The difference between an exhausting, but just good year, and one to forget", says Luck.

In the Upper Engadine, prices for luxury real estate are shooting through the roof. (Image: Shutterstock.com/CSnafzger)

Prices in the luxury real estate segment continue to rise. In and around the major centers of Geneva and Zurich, prices climbed by around 10% and 12% respectively on average. But the market for luxury properties is likely to lose considerable momentum, predicts UBS.

The upward spiral in the luxury real estate market also continued in 2021. Properties in luxury locations in Switzerland were offered at prices around 10% higher than in the previous year. The increase was thus three times as high as the average for the last decade. Compared to the market as a whole, real estate prices in the luxury segment increased about twice as much in 2021, according to the annual study "UBS Luxury Property Focus 2022" shows.

Front-runner Upper Engadine

Accordingly, luxury real estate is becoming more expensive in all the regions analyzed. Above-average price increases were recorded in the top locations of central Switzerland. In and around the major centers of Geneva and Zurich, prices climbed by an average of around 10 and 12% respectively. In the luxury mountain destinations, however, the development was mixed. In the Upper Engadine, strong price increases in the low double-digit percentage range continued for the second year in a row. In Ticino, prices rose only for condominiums, but fell slightly for single-family homes. In the Valais Alps, prices developed partly below average.

Thus, according to the study, the Upper Engadine records the highest prices for luxury properties. For prime properties, they are above the CHF 31,000 per square meter mark. In the primary residence markets in and around the cities of Geneva and Zurich, as well as in central Switzerland, the luxury segment starts at a level of just under 24,000 Swiss francs. Only in Ticino are luxury properties changing hands from around CHF 19,000 per square meter upwards.

According to UBS real estate economist Katharina Hofer, the strong market development in the luxury segment was largely due to the considerable increase in assets as a result of a very good year on the stock market. This allowed for an increase in the number of interested parties in the mid- to high-single-digit million price category. This increased demand met with a fundamentally limited supply in the prime locations. As a result, many properties found a buyer relatively quickly and did not need to be advertised online. As a result, the number of advertised properties in some of the prime locations slumped by between a third and a half compared to pre-Corona levels.

Reversed signs for leading indicators

UBS expects domestic demand for luxury real estate to experience a damper in the current year. First, a turbulent year on the stock market so far is unlikely to allow for asset gains of the same magnitude as the previous year. Swiss economic growth – a key driver of demand for luxury properties – is also expected to slow year-on-year in 2022. At the same time, demand from the euro zone will be less strong due to the loss of purchasing power caused by the weaker euro against the Swiss franc.

Another finding: the Corona pandemic permanently changed some determinants of demand for luxury real estate in favor of the federal destinations. Especially in times of geopolitical uncertainty, Switzerland with its stable institutions offers a sought-after retreat, according to the real estate economist. In their view, this is likely to maintain interest in properties in prime locations in general.

Nevertheless, rising financing costs, asset losses and economic uncertainty are likely to moderate willingness to pay for luxury properties. Thanks to a strong first quarter, UBS expects prices to rise again in the mid-single digits this year, but the upward trend in the Swiss luxury market, which has now lasted four years, is likely to lose considerable momentum.

As a general rule, a tax return must be filed after one year in Germany. Depending on whether this results in a surplus or an additional payment, the person receives a tax credit or has to pay back taxes. However, that does not apply to capital gains. Because the capital gains tax is withheld immediately when the capital amount is credited to the source, which is usually the bank, and from there it goes directly to the tax office.

Part of the income tax law

Capital gains tax is one of the types of income covered by the Income Tax Act. It must be made in principle for all income arising from capital. These include:

Dividends from shares
Interest
Exchange Gains
Income from life insurance policies

The amount of this tax is 25 percent of the capital gains that exceed the statutory exemption amounts. In addition, the solidarity surcharge and, if applicable, church tax must be paid. If the income exceeds the exemption limit, the capital gains must be declared in the income tax return.

Who doesn't have to pay capital gains tax?

Those who have low incomes or are retirees or. Is a student, can apply for a so-called non-assessment certificate at his competent tax office. This exempts those concerned from the capital gains tax liability for up to three years. In addition, no capital gains tax is payable if the income from the capital is within the exemption amounts of 801 euros for single persons or. 1602 euros for married couples lie.

The tax is paid directly by the bank

Normally, the bank directly accounts for capital gains tax when the capital, interest or dividend income from securities and time deposit investments assessed there yields. The client will receive an appropriate notice from the bank, which must be included with income tax returns. Only then can the amounts already paid be taken into account. It may happen that the tax payment already made will be refunded as well. This occurs when appropriate supporting documentation is provided and a request is made for what is known as a favorable test.

Capital gains tax is withholding tax

Basically, every profit from a capital gain must be taxed accordingly. Capital gains tax is a so-called withholding tax, which means that it is paid by the paying agent, i.e. the bank or. the insurance company, must be withheld directly and forwarded to the tax authorities. There are also different percentage deductions for the different capital yields. In principle, the tax rate is 20 percent for dividends, 30 percent for interest and a whopping 35 percent for anonymous table transactions. In addition, the solidarity surcharge of 5.5 percent and church tax of eight or nine percent must be added in each case. Incidentally, the latter is only withheld if the investor has submitted a corresponding application for the deduction of church tax to his tax office in advance. This is regulated in the Income Tax Act, more precisely in § 43 (a) as follows. With this deduction, the tax on the capital gains is subsequently reduced to a minimal extent. Who receives income from:

private loans
Interest from mortgages or land charges
in the case of pensioners, pensions from pension debts
endowment life insurance policies or sales of a silent partnership
Foreign currency transactions

refers, must lead also these naturally accordingly to a tax. Although they are not subject to capital gains tax, they are also not completely tax-free and must be declared in any case in the annual tax return to the tax office.

The difference between capital gains tax and final withholding tax is simple

The terms capital gains tax and final withholding tax are often used synonymously. But this is not quite right, because the capital gains tax is a pure form of the final withholding tax. This has been available in Germany since 01. The flat tax was introduced on January 1, 2009, and has since replaced the previous taxation of income from capital gains. Previously, these were taxed either as capital gains tax or interest withholding tax, and were reported on the tax return at the normal income tax rate. Since 2009 it is no longer necessary to declare capital gains annually, as they are already taken care of with the final withholding tax.

Simple fictitious example for illustration

Who has a savings book with 5000 euro credit balance, receives for it annually 80 euro interest credited. Before the 01.01.In 2009, the interest withholding tax of 30 percent had to be paid from it. This results in 24 Euro capital gains tax. Since 01.01.In 2009, the final withholding tax applies, which means that only 25 percent tax is due on the interest, i.e. on a credit balance of 5,000 euros, only 20 euros must be paid to the tax office.

Adding fuel to the fire

Puzzlement over Russia's course

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