Here Is Why Interest Rates Will Increase In 2022
In today’s video, I want to voice my opinion with regards to the interest rate behaviour moving into 2022.
Without further ado let’s get started.
1. My opinion on interest rate behaviour in 2022
For the context of this video, I will be referring to the US interest rate as they have a large influence on the global interest behaviour and also the interest rate’s behaviour here in Singapore.
In fact, from the behaviour of the US Federal Fund rate and our 3-month Singapore Overnight Rate Average, we can see that there is a very high correlation between our interest rates and the interest rate of the United States.
Having said that, I believe that interest rates will increase moving into 2022 but the increase that we will experience will not be that significant. At least not at a pace where it rises so far so soon.
Also, even though I expect interest rates to start increasing in 2022, I doubt we will ever reach an interest rates level that we have experienced previously before the 2008 Financial Crisis.
And there are good reasons for this, let me explain.
2. Why interest rate is set to increase
In my opinion, there are two factors that will drive an increase in the interest rate in 2022.
The first is the concern over a rising inflation rate that we are currently experiencing and the second is the fact that the economy had been recovering steadily since the start of the pandemic.
Let’s go through the points one at a time.
2.1 Rising inflation Rates
Regarding the first point on the inflation rate, I think everybody that is watching this can agree with me that generally, prices of goods and services had increased significantly in 2021.
In fact, if we were to look at the inflation rate numbers, you can see that the inflation rates that we are experiencing today is higher than what we had experienced in the last 10 years and the pace of the increase is very sharp.
What’s more, many of the policymakers believe that the inflation rate is “transitory” and that the rates will eventually decrease, many of them foresee the current inflation rates to persist for a longer duration before things turn for the better.
As I’ve explained in my explainer video, the inflation rate behaviour plays a significant role in the interest rate behaviour.
This is because, in a rising inflation rate environment, lenders will demand higher interest returns to compensate for the loss of their purchasing power.
At the same time, policymakers who use the inflation rate as a form of measurement on the current state of the economy may be more cautious about their interest rates target to prevent the economy from overheating due to the presence of cheap money caused by low-interest rates target.
2.2 Steady Economic Recovery
Regarding the second point on economic recovery, given the fact that the current low-level interest rates were a deliberate attempt by the government and policies makers to alleviate the pandemic’s impact on the economy, now that the economy is recovering, the policymakers have one less reason to keep the interest rate at such a low level any more.
In fact, I would argue that there is more incentive for them to take this opportunity to increase their interest rates target as given how things are today, the government’s and policy makers’ hands are pretty tied when it comes to the instruments available to stimulate the economy.
Interest rates are already at such a low level that if another wave of economic slowdown and recession were to occur today, there is nothing much the policymakers can do when it comes to trying to use the interest rate to stimulate the economy.
As a result, they will have to rely on other instruments to stimulate the economy mainly the fiscal side of things such as reducing taxes and increasing government spending.
That said, by gradually raising the interest rates when the economy is recovering, the policymakers are essentially gaining back one of the instruments that are available to them should they need to use it to stimulate the economy again in the future when it slows down.
Given the fact that the Gross Domestic Product had recovered to its pre-pandemic levels and the employment situation had significantly improved since 2020, I find it unlikely that the government and policymakers would want to keep interest rates at such a low level for a long period.
2.3 Summary on interest rate increases
In short, based on the current situation, it is more likely than not that the interest rates will increase as it is in the interest of all parties – apart from the borrowers – that the interest rate increase instead of maintaining at its current levels.
Lenders demand a higher interest return to compensate for a loss in purchasing power due to the inflation rate and policymakers will want to set a higher interest rate target to
prevent inflation from going out of control
prevent the economy from overheating
gain back the effectiveness of using interest rate as an instrument to stimulate the economy in the future should the economy experience another slowdown
That covers my opinion as to why I believe interest rates will increase moving into 2022, now let us move on to my next point in this video.
3. Why interest rate will not reach its previous high
While the interest rate is most likely going to increase in 2022, I do not foresee interest rates reaching the levels that we’ve experienced before the 2008 financial crisis because of two reasons.
private debt levels are at an all-time high
inflation rate is to a certain extend transitory & unlikely to go out of control
3.1 Private debt levels are at an all-time high
The interest rate is essentially the price of money.
As interest rates increases, the cost to the lenders and business increases and as a result, their profitability and bottom-line decrease.
On this point alone, I would argue that the interest rates would not reach a level before the 2008 financial crisis as currently, private debt and borrowing levels are at an all-time high.
In fact, private debt levels today far outweigh the levels that we’ve experienced before the 2008 financial crisis.
Because of that, I doubt the government and policymakers would allow interest rates to be too high as the interest cost to businesses will become a form of economic drag that reduces the overall economic performance.
Think about it, for every dollar of interest cost incurred, that is a dollar that is taken away from the business to perhaps reinvest and generate higher profitability down the road.
What I think is going to happen is that as interest rates increases, businesses will start to feel the impact on their bottom line and as a result economic activity will start to slow down.
When that happens, we will go through the same cycle as we did previously where the government and policymakers will step in to control and lower the interest rate to spur on economic activity to a level that they deem is healthy.
As such, while the government and policymakers have an incentive to increase interest rates moving forward, I doubt we will experience a rate that we’ve seen before 2008 simply because the cost to the economy is too high should that happen.
3.2 Inflation is somewhat transitory
On the topic of inflation and whether or not it is transitory, I do believe that, to a certain extent, that the current inflation rate is transitory as it is the result of global supply chain issues that we are experiencing today.
That being said, it also means to say that should the situation alleviate and the global supply chain recovers, inflation would, by theory, come down.
Now I understand that this is a very one-dimensional view on the topic of inflation, which is why I’ve decided to go more inadept on this topic in next week's video/article.
4. Closing: What does this mean to you?
Now that we’ve explored some of the factors that might cause the interest rate to increase in 2022, what does this mean to you?
Long story short, when it comes to a rising interest rate environment, you should…
1. Be careful when refinancing your loans and mortgages, especially if you are currently on the HDB loan and thinking of refinancing to a bank loan to try and take advantage of the current interest rates.
2. If you are currently borrowing to invest, you might want to take a closer look at how an increase in the interest rate will affect your overall profitability and take necessary precautions to prevent suffering an investment loss when the interest rate increases