Where are interest rates going this year? A look at the strategies used by Central bankers

The FOMC will meet on Friday night and decide whether to raise the interest rate. Markets have priced in a 25Bps hike. Here's what we think will happen

You’ve read the headlines; Interest rates are rising. The markets are pricing in this, the markets expect that. Property values are down, stonks are dead, crypto is dead, and chivalry is dead. All because of rising interest rates.

The FOMC will meet on Friday night and decide whether to raise the interest rate. Markets have priced in a 25Bps hike. A far cry from when they were raising rates 50Bps on a whim.

But this isn’t the first time the sledgehammer of monetary policy has been wielded by the Central banks of the world. Their toolbelt has many strategies.

One such example is the use of ‘Open Market Operations’. In essence, there’s the rate you’re charged for a mortgage and there’s an overnight rate that banks charge each other for lending money. When you send your mate money, chances are it settles when the sun goes down and this is when the bees at the banks are buzzing around, lending and borrowing from one another to balance their sheets and earn a little interest by doing so. It’s a neat little side hustle for them.  

The Open Markets Operation is a more indirect method a central bank will use to influence monetary policy

The above photo shows how the Fed implements a soft-touch approach to interest rates via banks. This is known as Open Market Operations. A central bank can lower the interest rate by purchasing securities (bonds and timeshares in the Bahamas) from banks in exchange for cold hard cash. They inject money into the money supply and put downward pressure on Interest rates. The inverse can also happen when they sell securities they own to banks, pull money out of circulation, and put upward pressure on the rate.

Whoever told you that the private market and the government don’t need to mix, needs to read this article.

But we’re getting off track. Open market Operations are a scalpel approach. What we’ve seen so far is the sledgehammer. But like all cycles, this has happened before. It has happened before AND IT WILL HAPPEN AGAIN.

In order to help you navigate it, we’re going to assume what the strategy of Central Bankers is and put a rough calculation on when our wallets will stop getting slapped around.

It’s Called ‘Front Loading’ and it can be seen in this picture below.

This image shows how interest rates have moved in the United States since 2005

Central banks have historically engaged in front-loading, i.e. they induce sharp initial increases in policy rates. In 2022 most countries entered the Interest rate Grand Prix where it became a sprint to increase rates the fastest. This has now tapered off. In order to curb a catastrophic recession in 2023, Reserve banks acted fast and severely. They read the record inflation and boom in the job market as a tell-tale sign that there was some pain on the horizon and acted pre-emptively.

To spray as much cold water on the economy while it was hot before it incinerated itself. This is front loading, a preemptive strategy to apply severe pressure on markets in order to dampen the intensity of an economic crisis that may be looming.

Harkening back to the original point, markets have priced in a 25Bps hike on Friday night. The world’s Central Banks will be looking to the United States and how it tapers its hikes.

You don’t immediately go from a sprint to a stop, there is inertia and deceleration before you slow your pace. The same rule applies.

Our view is that Central banks will begin to slow the large increments of rate hikes as they bring the 50Bps hike down to 25Bps. Markets will need time to absorb this and we will see quieter hikes till we pierce 5% as we did in 2007. We may even see peaks of 5.25% before a gradual cutting of rates beginning in late Q2 to Q3.

The pain has to stop at some point… Right?

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