Navigating Rising Interest Rates.
Interest rate movements tend to be pretty predictable, except when they’re not.
I was a commercial banker sitting in the office of a client who had fixed in the vast majority of his commercial property exposure at about 6.5% p.a. He had about 12 months to go on this. It was late 2020. Fixed rates were sitting below variable and, in conjunction with a specialist, we had come up with a mechanism to get out of the hedge early and re-hedge at a much more favourable rate.
The client commented that he had taken all the downside of interest rate reductions by hedging in 2015, and that rates were going to stick low for a while, so why hedge at a higher rate than the variable. He has been burned before.
Of course we know what happened. Rates worldwide shifted up unpredictably due to external unforeseen circumstances such as food and fuel costs, supply, war and COVID support payments causing supply side inflation.
In recent years, we have witnessed a shift from historically low interest rates to an environment characterized by rising rates. This shift has significant implications for consumers, investors, and businesses alike. One of the most crucial decisions borrowers face is choosing between fixed and variable interest rates. Each option offers its unique set of advantages, and in a rising interest rate environment, understanding these benefits is paramount. Many retail borrowers have prevailing low fixed rates ending in the coming months and may be thinking ‘why on earth would I fix in again at a higher rate?’
Framed a different way, commodity hedging is extremely common among businesses with inputs, and foreign exchange hedging is equally as common for importers and exporters. Non financial corporations hedged about 1/3 of their FX payments in 2022 according to the RBA. On average, all other things being equal, with the financial cost of hedge, hedging FX means you will be worse off. So why do so many business’ hedge their FX but not their interest rate exposure?
The answer is simply that interest rates movements appear less drastic and more obvious than currencies, but this isn’t the case. It is only the case when there aren’t unexpected influences that are unpredictable anyway.
Picking the market can make you feel like a genius or a fool, but limiting the risk of repayment to something you can afford is invaluable regardless of if you could be paying less. There are many rate hedging products available to business and consumer be it a combination of fixed and variable, cap and/or collar and forward fixing options. It might be that variable rates is the solution for you, but its always worth putting in more thought than you put in trying to pick which will be more cost effective.
