Changing Tides: The Moves Away From Low Interest Rates

The central banks across the world reduced interest rates at the onset of the pandemic, to make money available at a lower cost to stressed sectors and to kickstart quantitative easing. Quantitative easing is an instrument to encourage lending and investment by purchasing securities from the market. The central Banks across the world, including the Reserve Bank of India, started buying securities from the market and made money available to households and businesses at lower interest rates through lending. The Federal Reserve of the United States (The central bank of the USA) itself added more than $4 trillion of monetary stimulus. However, the central banks have finally started shifting gear and ending the era of easy money.  

The easy availability of money at a lower cost worldwide for the last 20 months has led to asset price appreciation in the equity market, real estate market etc. However, demand and supply mismatch has also led to higher inflation across the developed world and emerging countries. Therefore, the central banks have started withdrawing the easy availability of money from the market due to the higher inflation persisting across advanced and emerging economies.  

The low interest-bearing financial condition helped the economies revive demand across sectors, which happened faster than anticipated, whereas the supply side problems have persisted. This combination of demand and supply has led to higher inflation across the globe.  

The Federal Reserve regarded the inflation as transitory at the beginning, but inflation has become more persistent, it has retired the word “transitory” in the context of inflation.  

Fed has also clearly mentioned that they intend to end the bond purchase program in the next two meetings. They have doubled the reduction of bond purchases during the December’21 meeting to $30 billion per month from $15 billion earlier. The Federal Reserve is expected to raise the interest rate three times during 2022 as per the December’21 policy meeting details.  

The Bank of Canada has also stopped the quantitative easing officially in October’21 in the backdrop of robust recovery and rising inflation. The Governor of the Bank of Canada, Tiff Macklem, said that Canada is getting closer to full recovery and no longer needs quantitative easing.  

The Bank of England has already increased the interest rate in December’21 meeting to 0.25% from the pandemic-era lows of 0.10% due to the rising inflationary situation in the United Kingdom. The Consumer Inflation (CPI) in the UK reached 10 years high at 5.1% in November’21, significantly higher than the targeted inflation of 2%. 

So, globally, the low-interest rate era that lasted for nearly 20 months is now being tightened and thus emerging markets may witness pressure from Foreign Institutional Investors (FIIs) in the near term as they tend to rebalance their portfolio from emerging markets to developed markets when interest rates rise.  This shift from a low interest rate regime to a rising interest rate regime may also lead to volatility in the equity markets.  

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