By Yacoub Haddad | Staff Writer
Figure 1: market performance from 2013 to 2022
In an extremely inflationary scenario, such as the one the world experienced in 2022, equity markets fluctuate with a volatility almost equivalent to that of bitcoin. Rising rates impact the business world in an extreme manner, as they increase the attractiveness of T- bills due to higher yields, in addition to making borrowing costs more expensive for businesses and personal reasons.
So why does the government utilize higher rates? The US has increased the Fed Funds Rate over the past year by nearly 5%, crashing the entire equity market by approximately 20% (using the S&P 500 as a benchmark), wiping out nearly 7 trillion USD in market value. If rising rates have this much of a negative impact on the investment market, why implement the measure?
The US Fed generally has three goals; control inflation (less than or equal to 2% per year), maintain growth (generally at 3% per year estimated by GDP), and control unemployment. (Less than 4%). These three goals are completely conflicting, as controlling growth requires lowering rates, whereas combatting inflation requires rising rates. Equity markets have been in a perpetual growth cycle since the 2008 financial crisis, and with the economic recovery from COVID, a rise in interest rates was warranted, to deter spending and encourage saving.
The US benefited from raising rates as it made the US dollar a high yielding currency.
Figure 2: change in value of the US dollar relative to other currencies
Investors fled to the US due to its perception as a risk-free investment, with US T – bills skyrocketing over 2022. Overall, this strategy allowed the US to somehow export its own inflation to countries within the EU, as well as Japan (the Russian Invasion of Ukraine didn’t help much either).
Overall, equity markets are extremely negatively impacted by increases in interest rates, however, these rate hikes are required to keep inflation in check and ensure that the world economy does not plunge into a recession.