- On 26 January the Federal Reserve made clear it would raise rates ‘soon’, meaning its March meeting.
- It would later shrink its balance sheet, the assets it had bought: it would be the first rate rise since 2018.
- With higher rates, loans, mortgages and credit lines become more expensive; it is worth checking which debt is variable and when it falls due.
On 26 January 2022 the US Federal Reserve made clear it would raise interest rates ‘soon’, meaning its March meeting, and would later shrink its balance sheet. It would be the first rate rise since 2018. The message confirmed the timetable and the end of a period that had shaped the financial life of companies and families for years. It was, in essence, a notice given months ahead so that everyone could prepare.
The Fed is the central bank of the world’s largest economy, and its decisions influence the price of money well beyond the United States. When it announces a change of course, the effects reach debt markets, banks, mortgage rates and the financing decisions of companies and families. That is why it is worth understanding what it says, and what it does not say, before the change reaches one’s own economy. A central bank’s words are scrutinised because they anticipate decisions that change the cost of borrowing.
What it actually said
A central bank pursues price stability mainly with two instruments: the price of money, that is, interest rates, and the size of its balance sheet, which reflects the assets it has bought. The Fed was announcing that it would begin to use both in the opposite direction from recent years.
Raising rates makes credit dearer and tends to cool demand; shrinking the balance sheet withdraws liquidity from the system. Both measures push in the same direction: slowing the rise in prices. They are not automatic decisions, because the central bank adjusts them according to the data, and the timetable can change if circumstances change. It is therefore useful to follow its announcements with prudence and without assuming a fixed timetable.
The end of free money
The era of free money was coming to an end. When rates rise, every loan, mortgage and credit line becomes more expensive, and the relative appeal of different financial assets changes too.
During the years of very low rates, borrowing was cheap and waiting cost little. With higher rates that equation reverses: money again has a noticeable price, and both company projects and mortgage payments must be assessed with different figures. Each person should judge how it affects them according to their situation and horizon. For some, higher rates mean larger repayments; for others, better returns on cash; hardly anyone is left unaffected.
What to do about debt
For any company with debt or planning to borrow, it was time to lock in terms before the market made them more expensive. It is worth checking what share of the debt is at a variable rate, when loans fall due and how much room the accounts have if financing costs go up. A simple simulation with higher rates is usually more revealing than any forecast.
Locking in terms is not always the best option: it depends on the term, the cost of the hedge and the income forecast in each case. What matters is that the decision is a conscious one, with the numbers done and a cushion for the less favourable scenarios. Talking to the bank and to a financial adviser before costs rise allows more room to negotiate. The best time to talk about financing is when it is not urgently needed.
Anticipating a change of cycle costs far less than reacting once it has arrived.
This article is general information. It is not legal, tax or investment advice, and it does not take anyone’s particular circumstances into account.
