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Interest Rates and Inflation
The macroeconomic variable that corporate financial managers should be preparing for in the next 5 to 10 years is the interest rate. If rates rise, markets are going to turn downward quickly. Low rates makes it easier to borrow, easier for companies to issue cheap debt, and easier for the government to do the same (Hall, 2019). If rates rise, debt becomes expensive and if the economy is carrying too much debt and individuals and companies are over-leveraged a serious crisis could occur in the market. The downside to keeping interest rates low is that it encourages risky borrowing and investment in risk assets like equities. If people cannot earn a decent return on investment by putting their money in savings, they will put their money into equities, which will cause a bubble in stocks—like what can be seen today. Stocks are historically overvalued and yet they continue to rise because rates continue to fall and the Federal Reserve also continues to pump new money into the market, which causes inflation. As the value of the dollar declines, investors seek assets that will maintain the value of their wealth—so they jump into precious metals or bonds or real estate, which sends the prices of these asset classes soaring.
Thus it can be seen that interest rates and inflation are essentially tied at the hip: low rates keep the debt scheme going, liquidity injections cause inflation but also allow banks to print the debt away. Financial managers will require the skill needed to monitor real inflation and find assets that can preserve their wealth. The key will be to avoid bubbles, which means finding an asset class that others have not yet jumped into. For some this can be gold or silver—but those can get bubbly. Active management will be the key to success; too much risk is involved in passive management. Active management will be required to prevent a blow-up and to move money quickly when the market turns. This means one’s life must be dedicated to staying on top of the market and not taking long vacations away from what the news.
References
Hall, M. (2019). How do interest rates affect the stock market? Retrieved from https://www.investopedia.com/investing/how-interest-rates-affect-stock-market/
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