The Fed speeds up and the ECB sets an end date

On 15 December 2021, the Federal Reserve doubled the pace of reducing its bond purchases and anticipated several rate rises in 2022. The next day, the ECB announced the end of its emergency programme in March. The two major central banks agreed on the direction, though not on the pace, and thus gave a clear signal that the era of ultra-cheap money was coming to an end. It was the moment markets had been anticipating for months, though that did not stop it having an effect.

For those who had built their financial decisions on the assumption that rates would stay low for a long time, those two days meant a change of scenario. They were not isolated decisions but the confirmation of a path that had been hinted at since the summer. And although the actual rises had not yet arrived, the timetable was already on the table. With a timetable, planning is easier than with a mere intention.

Two decisions in two days

The Federal Reserve is the central bank of the United States and the ECB, that of the euro area. Their decisions on bond purchases and interest rates end up influencing the cost of mortgages, loans and corporate financing on either side of the Atlantic.

The Fed was going faster; the ECB, somewhat more slowly. That difference reflects that the circumstances of each economy are not identical: inflation, growth and economic policy priorities differ on either side of the Atlantic. But both messages pointed to the same horizon, that of less expansionary monetary policy and money that will cease to be so cheap. Each central bank acts according to its own mandate and its own data.

The change of cycle

The change of cycle was beginning. After years of very low rates and massive bond purchases, monetary policy was going to tighten. For markets, that means revisiting valuations; for the economy as a whole, a cost of financing that will no longer be as favourable as in recent years.

The end of a monetary era does not arrive all at once, but it does arrive with consequences. The effects accumulate: new loans cost more, variable-rate mortgages become dearer as benchmark rates rise and investments that were justified with cheap financing have to be reassessed. Those who foresee it can adjust in good time and avoid strain. Those who wait until the change is obvious usually have fewer options.

Rates, once again a first-order variable

For families with variable-rate mortgages and for companies with debt, interest rates were once again a first-order variable. It is worth reviewing how much debt is at a variable rate, what margin there is in the household or company budget to absorb higher instalments and what alternatives lenders offer. Also whether future income will grow at the same pace as the cost of the debt. An adviser can help to compare scenarios.

A useful exercise is to simulate what would happen to instalments if the benchmark rate rose by one, two or three points, and check whether the budget could bear it without strain. If the answer is no, it is time to study measures such as fixing part of the rate, repaying capital or strengthening cash reserves. Each measure has a cost, and the cost of acting should be compared with that of waiting. Low rates were a circumstance, not a rule.

When the environment changes cycle, the prudent course is to review the accounts before the instalments do it for you.

This article is general information. It is not legal, tax or investment advice, and it does not take anyone’s particular circumstances into account.