This is issue #088 of our newsletter, where we talk about interest rates. Subscribe now and never miss an issue!
US Raises rates (what that means)
On Wednesday last week, the United States Federal Reserve (aka the American Central Bank) announced that it raised its base interest rate by 0.25%.
Now, depositors at the Central Bank will receive an annual rate of 0.40%.
What’s more is that the Federal Open Markets Committee (FOMC), which has the final say over these matters, pledged to increase them six more times this year.
Although this increase was the first one since 2018, it was long expected by economists, banks, investors, and other pundits.
We’ve talked about inflation a lot lately, as, by the numbers, it’s gone up steadily over the past few months.
Even if many of today’s inflation pressures stem from issues related to the supply chain, rising energy costs, and now, a war, the Fed saw now as the time to act.
Furthermore, unemployment in the US is near historical lows, at just 3.8%. Meanwhile, American economic growth is robust, at 7%.
The Federal Reserve and other major central banks traditionally have two roles when it comes to managing the economy:
- Ensure that the economy can get as close to full employment as possible.
- Control inflation
With the first goal met, officials set out tackling the second one.
Impacts of the rates increase
The impacts of this rate increase and subsequent ones will touch every aspect of society.
For one, it makes investing in stocks riskier since the gap between the risk-free rate of return (what you get for leaving your money in the bank) and the stock performance shrinks.
The markets reacted accordingly, with stocks dropping broadly when Fed Chairman Jay Powell spoke. Yet, the market quickly recovered, continuing the upward trend of the last few weeks.
Second, for us living abroad, changes in interest rates impact exchange rates. If the US continues to raise rates while Europe doesn’t, the dollar will strengthen.
Beyond the effects on remote workers, global stock markets will also feel the impact. While diversification through funds like ETFs help, it certainly isn’t making life easier for us.
However, there are far too many unknowns right now for all of the talk about subsequent rate increases, many of which didn’t even exist a month ago.
The war in Ukraine continues to add more unpredictability and volatility to the global economy. As we wrote last week, we’re not sure yet what the long-term impacts on commodities will look like.
Even if Europe is more exposed to Ukraine and Russia economically than the United States, we still have a globalized economy.
If growth slows down or joblessness goes back up, the Fed will need to reconsider its interest rate policy.
Okay, if you’re still with me, you’re probably thinking, “WTF?” and you have a point.
For us, our best course of action means continuing to make long-term investments without letting our emotions get the best of us.
We can’t control the economy, but we know that markets tend to go up over the long run and that we’ll win if we stick to our plan without emotions getting in the way.
The UK raised rates, too.
Not to be outdone by their former colony turned slightly-unhinged ally, the Bank of England also announced an interest rate rise last week.
Today, the base rate sits at 0.75% (up from 0.50%), which, coincidentally, is the same level it was in February 2020.
Like the United States, the UK also faces strong price growth, again driven by supply chain disruptions and energy costs.
However, unlike the US, the British are dealing with Brexit and the subsequent price increases from imports. (Many items now face duty since the UK left the common market).
The Bank of England was the first big economy to raise rates since the pandemic started.
Like with the dollar, changes in the interest rate in the UK versus other currencies will impact the pound.
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China up, China down, China all around
Even if the war in Ukraine remains within its borders (for now🤞), the economic and geopolitical impacts are global.
China is no exception and last week was a wild one for Chinese stocks. In short:
- Chinese stocks have been in decline since the beginning of the year;
- Fears that new lockdowns in tech-heavy Shenzhen caused an even bigger sell-off;
- Investors were increasingly concerned that the West would economically sanction China if it helped Russia evade economic punishment for their way;
- There’s still the looming risk of a massive Evergrande debt default.
By the beginning of the week, these concerns created one of the most significant stock market drops in Chinese history, but then:
- The Chinese government adjusted their language towards Ukraine to distance themselves (a bit) from Russia;
- The lockdown was lighter and shorter than expected
- The financial policy committee released a statement pledging support to stabilize the country’s financial markets.
Chinese stocks immediately reversed their precipitous decline while climbing at a record pace.
This change of events is probably welcome for savvy index investors who hold emerging market and/or APAC ETFs.
While we don’t know how long the rally will last, the promise of some stability is always music to our ears.
EU crypto rules getting closer
Our friends in Brussels are working as hard as they can (😉) to help give cryptocurrencies a proper legal framework.
As part of this process, members of the economic and monetary affairs committee rejected a proposal to ban proof-of-work mining.
If you’re not familiar with what “proof-of-work” is, don’t worry, you’re not alone.
In short, the way cryptocurrency works is that every transaction gets verified and then written to a ledger called the blockchain. The machines — or rather their owners — who complete validation get rewarded with a “mined” cryptocurrency.
Proof-of-work is a type of verification where the computers have to solve complex algorithms to write the transaction to the ledger.
As you can imagine, performing deep math problems takes a lot of computing power and, in turn, energy.
In its pursuit of a greener economy, the European Commission tinkered with a rule banning proof-of-work.
While the measure failed, the stakes were high as the world’s most popular cryptocurrency — Bitcoin — uses proof-of-work for transaction processing.
The EU would’ve effectively banned Bitcoin from its soil if the measure had passed.
For now, Bitcoin in Europe lives to see another day.