We always hear news about the Federal Reserve raising interest rates, the UK raising interest rates, and the People's Bank of China lowering interest rates. Central banks of various countries are taking big actions. So what is the logic behind these operations? How do interest rates affect the economy? Let's talk about this today.
1. Why are interest rates so important?
When the central bank finds that the economic situation is not good, it begins to lower interest rates. As long as the interest rate is lowered, the interest on bank deposits will become less. The funds in the capital market are very sensitive and profit-seeking. When the money in the bank does not earn any interest, other investment products become relatively attractive. Funds will gradually flow out of the bank and flow into products with high investment returns or be used for consumption, such as buying houses, cars, bags, stocks, funds, opening restaurants, etc. In short, it will reduce savings and increase investment and consumption.
At the same time, bank loan interest rates will also decrease. Everyone will rush to borrow money. Companies will take out loans to expand construction and invest in production, and individuals will take out loans to buy houses and cars. The entire investment, production and consumption chain will become active. The money borrowed from banks will flow into the market, just like injecting fresh water into a swimming pool, driving the recovery of the entire economy.
As all industries expand, the economy becomes better and better, there is more and more money in the market, the income of the people and enterprises increases, the consumption capacity also increases, and the demand also rises, but the supply cannot catch up in a short period of time, so things become more and more expensive, and finally push up inflation. This is also a natural phenomenon when the economy is in the expansion stage.
If there is too much money in the market, causing inflation to grow too fast, the central bank will step on the brakes and even start raising interest rates. When bank deposit rates increase, a lot of funds will begin to flow slowly from the stock market, bond market, funds, and real estate to banks.
At the same time, loan interest rates are gradually increasing, and the repayment pressure on enterprises and the public is increasing. Fewer people are taking out loans, and those who have already taken out loans will reduce their spending and speed up their repayments. As a result, money in the market is gradually flowing back to banks, so raising interest rates has the effect of recovering funds.
Then there is less liquidity in the market, purchasing power decreases, supply exceeds demand, prices fall, and finally it turns into deflation and the economy goes into a downturn. So banks start to adjust interest rates and release money. This is the relationship between the economic cycle and the rise and fall of interest rates, which is also the interest rate hike cycle and interest rate cut cycle that we often hear about.
2. What is the relationship between interest rates and the secondary market? How does an interest rate hike affect the secondary market?
(1) Company perspective
As interest rates rise, the costs of borrowing or issuing bonds for listed companies are increasing. For companies, financing costs become higher and company development is hindered, so it is bad news for the secondary market.
The interest rate hike will have a greater impact on industries that need to refinance. If a large part of a company's balance sheet is debt, especially short-term debt, then the interest rate hike will have a big impact on it.
However, the interest rate hike is beneficial to some industries, such as banking and insurance. After all, banks make money from the interest rate spread between lending and borrowing.
(2) Consumer perspective
After the interest rate hike, the interest rates on everyone’s mortgages, car loans, and credit card loans will increase, the repayment pressure will increase, people will reduce consumption, overall demand will decrease, and it will be more difficult for companies to make money. Therefore, from the consumer’s perspective, it is also bad news for listed companies and the secondary market.
The impact is particularly greater on industries that rely on loans, such as houses and cars, because people have to take out loans to buy these things, so the blow to these companies is greater. The impact on general daily necessities is relatively smaller. After all, I’ve never heard of anyone taking out a loan to buy toilet paper, right?
(3) Valuation perspective
The interest rate on the valuation of the secondary risk market is like gravity. When the interest rate is low, the company's valuation will be relatively high. When the interest rate rises, this gravity will pull the company's valuation down.
For a company, once the interest rate becomes higher, the discount rate will become higher, which means that the future money will become less valuable when discounted to the present. This is especially true for growth companies, whose profits will come in the future, so the present value will be smaller.
Therefore, from a valuation perspective, rising interest rates are also bad news for the secondary market.
(4) From the perspective of capital flow
The central bank’s interest rate hike has tightened liquidity in the entire market, short-term investors are short of money, and this is also bearish for the secondary market. This is also the most direct impact.
What is mentioned above is only the impact on the secondary market to a certain extent, but the reality is far from that simple.
For example, it was mentioned above that interest rate hikes generally occur during periods of inflation, but during periods of inflation many people will choose to buy houses to hedge against inflation. From this perspective, it is good for real estate, which creates a contradiction.
So the economy is a very complex thing, everything influences each other and is intricately intertwined.
When the central bank announces an interest rate hike, it is usually bad news for the secondary market, because the secondary market is sometimes based on speculation on expectations, and after a period of time it will have almost no impact.
3. Finally
After the financial crisis in 2008, the world entered a channel of falling interest rates. Major economies in the world adopted low interest rates to force money out of banks. Japan and the eurozone even implemented negative interest rates, which means that not only will you not earn interest if you deposit money in the bank, you will even have to pay a storage fee to the bank. Although our interest rates have not dropped to zero, the interest has long been unable to resist the rate of inflation.
In order to save the economy after the financial crisis, the United States took the lead in implementing quantitative easing. Simply put, it was to throw money into the market by purchasing government bonds. After several rounds of quantitative easing, it printed money all the way and threw it into the global swimming pool, continuously pushing up asset prices.
Not only the United States, but the whole world is printing money like crazy, and the debt leverage crisis is getting bigger and bigger.
Today, the United States is withdrawing the money it printed in recent years by raising interest rates and shrinking its balance sheet. The speed of this pump is getting faster and faster, and the pressure of the asset bubble is getting greater and greater. In the end, whoever is swimming naked in the market will be exposed one by one.
The last rate hike is imminent, and we don’t know how the market will react. Let’s wait and see. #加息 #降息 #BTC