Are you confused about where interest rates are heading? If so, you are not alone. I don’t think central bankers know themselves what they should do about interest rates. They ought to. But they have tied themselves up in knots.
We do know that rates can’t possibly stay where they are, forever. It just doesn’t make any sense if they do. If the cost of money remains low, then there is little reason for asset prices to ever come down.
Is that really what we want? Or more importantly, is that what central bankers really want? Do they want investors to believe that there is no alternative to holding any asset, regardless of their perceived risks?
Could that be the reason why cryptocurrencies are enjoying their day in the sun? After all, if investors are earning nothing on their cash deposits, what could be so wrong with having a punt on some cryptos?
Problem is that central bankers have found themselves caught in no-man’s land. Some central banks, such as the US Fed, may like to obfuscate matters by saying that it has a responsibility to ensure full employment as well as manage inflation. That is just fantasy. It is just a fudge to play for time.
What we can say is that interest rates cannot conceivably remain at these ultra-low levels forever. They will have to rise sooner rather than later, given the way that inflation is looking more persistent than even central bankers would be comfortable with.
And the way things are going, sooner could come a lot earlier than we think. From an investor’s perspective, it means making sure that our portfolios are strong enough to withstand any interest-rate shocks.
That means poring over our stocks to identify heavily-indebted companies, those with poor interest-rate cover, and particularly those with little or no pricing power. These companies could be the worst affected when interest rates go up.
If we thought that going into a pandemic-fuelled recession was painful, coming out of one could be worse especially if we are holding the wrong shares. So, caveat emptor.
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David does not own shares in any of the companies mentioned.