Rates on the Rise

By: Karel Ellington, Trader Posted:

Coming out of the worst stages of the Covid 19 pandemic, a major concern for investors has been rising interest rates and the expectation of the same. Interest rate movements are one of the most significant and fundamental risks to economic stability and growth. Interest rates affect every asset class from Bonds to Foreign currency.

Globally, markets have enjoyed the most accommodative monetary policy stance from central banks in history as interest rates are at all-time lows and in some cases negative, for example in Japan and Germany. This loose monetary policy was a response to unstable financial markets featuring very low liquidity causing rapid price erosion in all asset classes. Quick response by the US Federal Reserve and other central banks like the Bank of England and or own Bank of Jamaica moved swiftly to lower interest rates and initiate bond buybacks. These combined actions placed a floor under asset prices, improved market liquidity, and has primarily caused prices to rally to levels now deemed overly rich in valuation.

Central banks have been careful and keen to communicate their path and pace of interest rate increases and more importantly the metrics that will be measured and observed when making the decision to move. With inflation and job growth identified as primary indicators for interest rate moves, investors can place themselves in a better position to gauge the timing of these increases, hence planning how they will rebalance their portfolios to reduce the negative impacts of this. Since the central banks have communicated the metrics that will signal lift off of rates, investors need to monitor headline indicators to help guide their asset allocation process, for example, jobs data (Unemployment rate, Payroll data, Participation rates), inflation data (CPI, PPI), and any action from the central government to increase fiscal stimulus must be noted as well.

Longer-dated bonds typically are more volatile at this time, high valuation growth stocks also become prime targets for price risk. Additionally, foreign currency rates are affected as investors reallocate assets to take advantage of expected currency moves based on the pace of inflation in that country.

At present markets are clear as to the indicators central banks are viewing to make their rate decisions, however, shadows have been cased on the inflation side as the raging debate is not if there is inflation in the economies but will be sustained long enough to warrant central bank responses. Is the inflation we now face transitory or not? This is now what will keep the market on edge. Central banks are of the view that price inflation presently is based on the huge bottlenecks in the global supply chain, however, as the world return to normalcy and people head back out into the economy these headwinds will dissipate which will increase the supply-side dynamics hence leading to price