How Do Higher Interest Rates Affect You?
Key Takeaways
Higher interest rates means 2 things:
A higher cost of borrowing for both you and companies,
Savers have an easier time with the ability to grow savings through instruments like T-bills and our Capital Holding account
It could affect things like property mortgages, and slow down business expansion plans.
However, as we have seen so far - it does not necessarily spell disaster for markets even if you are invested in equities.
Public opinion always wants easy money, that is, low interest rates.
Interest rates have increased substantially over the past two years, and at the moment, its unlikely that it could come back down anytime soon. If you are taking out a loan, it means that it's more expensive to borrow. Conversely, it also means it's more rewarding to save. Over the longer term, this change is good for the economy, but it can take some time to get used to — especially since we have been experiencing below average interest rates for more than 10 years.
The high interest rates we are experiencing now can impact us in various ways. For households, higher rates make it more expensive to finance loans such as mortgages and car loans. Theoretically it should lead to a reduction in borrowing activity as individuals find themselves forking out more for their monthly payments. However, if the Singapore residential property price guide (shown below) is any guide, it still does not appear to have slowed down our infamous desire to buy property!
A good thing that has happened from rising rates is that it presents people with an opportunity to earn more on their savings than they have in years. A quick check on the MAS website shows that a 1-year T-Bill is offering a yield of approximately 3.74% as of 23 Jan 2024. Money market accounts such as our Capital Holding Account will offer slightly above that. As such, savers who are looking to park cash for liquidity and emergency purposes will be able to retain their level of purchasing power better.
Higher interest rates also affect businesses as they face higher costs to borrow money. This may affect their investment decisions and potentially slow down expansion plans. It is likely that investors expected this to happen in 2023 which resulted in many forecasts of recession and a recommendation to underweight equities — neither of which rang true in the end.
So what can investors expect?
Because higher interest rates make it more expensive for companies to borrow money, they generally affect corporate profits and stock prices. This worry could prevent investors from allocating their capital to equities.
However, not all companies around the world are affected in the same way. For instance, a snapshot of the US large cap companies shows that the amount of company borrowing for refinancing is at a manageable level between 4 to 8% over the next few years. Thus, higher interest rates should not affect profits too badly.
However, smaller cap companies (shown by the Russell 2000) have higher amounts of loans maturing over the next few years — between 10 to 15% of their debt. As such, these companies could be more impacted by higher interest rates if they had to refinance them.
If you are searching for a reason why 2023 was not a bad year for stocks, innovative thinking behind company management could be a good reason. The diagram below shows the change in the debt composition of the largest companies in the US. As interest rates dropped to extremely low levels post-2008, companies took up more long-term fixed rate debt as a means to hedge their borrowing costs at low levels and to give their management a good sense of liabilities (diagram below).
With liability fixed at low levels, the recent rate hikes unlikely caused much impact to the balance sheets of these companies. However as interest rates continue to adjust, we should expect some level of volatility in the financial markets. Maintaining a long-term focus and adhering to your investment plan instead reacting to the market's day-to-day fluctuations will serve you well.
So will rates go up or down this year? There is no definitive way to tell. It can be tempting to make impulsive financial decisions based on your emotions. However, a financial advisor can help you stay on track by providing objective advice and helping you make sound decisions in your best interests. To find out more, click here to have a chat with us.
