High interest rates slow growth, are central banks raising interest rates too much?

Chart of the Week

In 2020, most central banks were still lowering interest rates, now the wind has definitely changed. All central banks around the world are now raising interest rates.

Why this is important

Central banks strongly influence financial markets with their policies. Their behavior usually has the greatest influence on prices. When central banks cut interest rates sharply, as they did in 2020, this is very positive for both equities and bond investors and points to rising prices.

Now, however, policy has turned. Rising interest rates mean falling prices for bond investors. In the last 30 years, you could be sure that if you bought a bond and had to sell it before it expired, you would make a small or large capital gain. From now on, however, it is clear that if you buy a bond and have to sell it before expiration, you will make a capital loss. If you buy bonds now, you have to hold them until repayment.

Stock prices also behave differently in such a market phase. The fluctuations increase massively. Announcements by central banks regularly drive prices sharply down. The most recent one was last Friday in the USA. U.S. Federal Reserve Chairman Jerome Powell said in an interview that interest rates must now rise faster than before. The stock markets dived after this statement, by almost 3%. It then needs good company results to drive prices further up.

Netflix: Price fall with announcement

On Thursday, Netflix announced falling subscriber numbers. The stock plunged almost 30% in one day.
Such a plunge in the share price is difficult to understand. Actually, it should have been clear to everyone that after the dreamlike growth figures in the Covid period, people are now going out again and watching less TV. Every investor also knew that many people share their passwords with friends. Every consumer should also have noticed that, in addition to Netflix, there are now many other streaming offers such as Amazon Prime or Walt Disney.
It sometimes helps to use normal common sense when buying stocks.  

The chart shows the maximum losses one could suffer with Netflix stock since its 2002 IPO. Since the high last November, the stock has lost over 60%. For bargain hunters it is now interesting, but it may still be too early to buy. At -75% to -85%, even lower prices could come.

There is also a well-known stock market saying: "Never catch a falling knife". One should not catch a falling knife in flight. It is much safer to wait until it hits the ground. Then you can pick it up without risk.

High interest rates slow down growth

For the American and his well-being, two things are very important. His car and his home. Over 60% of Americans own a home.

Gasoline prices have nearly doubled in a year and used car prices have skyrocketed in 6 months. And now it's hitting homeowners, too.

The chart shows the interest rate on a 30-year mortgage in the US. They have been steadily declining since 1984. By 2021, the winds have already shifted. Even though historically this does not look bad on the chart interest rates have almost doubled.

The chart compares higher costs for property owners and the ISM index. The Purchasing Managers Index, also known as the "ISM Manufacturing Index" or "ISM Purchasing Managers Index," is the most important and reliable leading indicator of economic activity in the United States. It is published by the Institute for Supply Management, a US non-profit organization based in Tempe.

The chart shows the relationship between the two indicators. When the cost of financing real estate increases, consumers have less money to buy goods and services. The doubling of financing costs means USD 1,000.- extra cost per month for the average American homeowner. So up to USD 12'000.- per year.

Rising financing costs are the most effective way for central banks to cool down a booming economy.

Although interest rates have already risen sharply, experts expect much more:

The chart shows the 0.25% March 2022 rate hike that has already occurred (blue) and the expected Federal Reserve (FED) rate hikes based on futures prices (red).

The focus is too much on the nominal inflation number, in our view:

The chart shows how badly the experts and the IMF (International Monetary Fund) have miscalculated. The light blue line shows the IMF's expectations in October 2021, when they expected inflation to peak in the third quarter of 2021, but now expect it to peak a year later (dark blue line).

We fear that the Fed is massively overreacting and slowing down the economy too much. The consequence would be a recession.

Normally, inflation shows up as a result of high demand. So it makes sense for the central bank to slow demand, as shown above, for example by increasing the cost of financing for homeowners.

Currently, however, we see high inflation because the supply chains are not yet in balance due to Covid and because energy prices are rising sharply due to the war in Ukraine. So currently we see problems on the supply side and not on the demand side. In such a case, it makes no sense to slow down the demand side.