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2022 was a year defined by a few different things. With supply chain issues leaking over from the pandemic, a war in Ukraine, and record-high inflation, the defining policy became focused on interest rates. In this article, we look at four different ways that rising rates had an impact on the world.
Futures Trading became more expensive
The interest rate rises in 2022 had different impacts on different types of Futures prices. Generally, higher interest rates increase the cost of leverage and lower interest rates decrease it. This means that traders need more capital to enter into Futures contracts when interest rates are high, impacting the Futures margin.
In 2022, the cost of money rose dramatically. Whilst there are many other factors that impact Futures, such as storage costs and dividends. If the underlying asset is expected to provide an income, then this will decrease the futures price too. In 2022, interest income rose, and so did the risk-free rate. Futures trading was already high risk, but now it’s arguably even more challenging.
House prices are set to decline
Interest rates affect property prices by influencing the cost and demand of borrowing money. The low-interest rates that we grew accustomed to made money cheap, meaning mortgages were attractive. This inevitably drives property demand and prices upwards. So, the rising rates of 2022 are expected to do the exact opposite.
This hasn’t yet been the reality. 2022 actually saw prices rise in both the US and UK, but other factors were at play. Supply is limited, government stimulus wasn’t too long ago, and it has been a matter of government objective in the UK to keep house prices rising.
But, analysts predict the rising rates will catch up with the property market, as they are set to decline significantly in 2023. Some estimate that the UK will see a 10% drop, whilst US homes are set to fall around 4.5%. For those looking to buy, this price correction may not be seen as a bad thing.
The USD gained strength
When interest rates are high, a currency becomes more attractive for investors who can earn higher returns by holding it. Not just the interest earned in a bank, but also from bonds. This increases the demand and value of that currency relative to other currencies.
In 2022, the US dollar strengthened against many other currencies due to rising interest rates in the US. Whilst other central banks also increased rates, the Federal Reserve acted aggressively and led the dance, raising them four times from 0.25% to 1.25% by December 2021. The Fed also started reducing its bond-buying program in July 2022, signaling a shift away from its ultra-loose monetary policy. The main motivations for this contractionary policy were, of course, inflationary pressures caused by the war in Ukraine.
The higher interest rates and tighter monetary policy made the US dollar more appealing for investors. But, it was also seen as the stable safe currency in a volatile time. According to Fitch Ratings, the US dollar reached historically high levels against several Fitch20 currencies. But, this was also because the Turkish lira among others saw drastic debasement due to out-of-control inflation. The stronger US dollar also hit some emerging market economies that have large external debts denominated in US dollars.
According to Trading Economics, interest rates in the US are expected to rise further to 5% by the end of 2023 as inflation remains elevated. This may continue to support the US dollar against other currencies, especially if other central banks lag behind or diverge from the Fed’s policy stance.
A European debt predicament
The European Central Bank (ECB) faced a difficult decision over interest rates in 2022. On the one hand, inflation in the euro area reached over 10%, well above the ECB’s target of below but close to 2%. This prompted the ECB to raise its key interest rate by 0.5% in July 2022 (0% to 0.50%) for the first time since 2011 – but it was a very minor increase in a time where contractionary policy is needed. Since then, rates have reached 3%.
The reason for this was that there are several countries that may be at risk of default with a steep increase in debt repayments. Spain, Italy, and Greece in particular are at risk of insolvency.
Growth in the euro area remained uneven and fragile due to various factors such as supply chain disruptions, labor shortages, energy crises, and political uncertainties. And, with the likes of Spain’s high rates of unemployment, it made the decision for raising rates even more difficult. A contractionary monetary policy would inevitably slow down the economy even more. Whilst it may cool inflation, it would worsen unemployment, demand, and productivity.
It turns out that, in a world where debt is the fuel of the economy, changing its cost of it has vast impacts. Many investors, bankers, and politicians will no doubt soon long for the times of cheap money, which incentivises rapid scaling startups, kept the property market growing, and ensured national debt repayments were low.
