Why have deposit rates increased

"If inflation and interest rates continue to rise significantly, the 'house of cards capital market' will start to falter”

Rising interest rates make many players in the financial markets nervous. The stock markets have also suffered a setback. Is a crash threatening now? Asset managers and economists have some arguments against it.

The players in the financial markets are increasingly relying on the "reflation" scenario. They are therefore assuming stronger economic growth as a result of overcoming the coronavirus pandemic, which would initially be very positive. As a result, however, inflation rates could also rise. On the markets, these expectations were expressed in the past week in a rise in interest rates - and also in falling share prices, especially in the case of American technology stocks, which have recently been very highly traded.

On the drip of cheap money

The development shows once again how much the financial markets depend on the drip of cheap money from the central banks. Many investors fear that rising inflation rates could mean that the central banks supply the financial markets with less cheap money than in previous years. “This topic will keep us busy all year round,” says Karsten Junius, chief economist at Bank J. Safra Sarasin.

In the US, US Treasury bond yields rose this week to their highest level in a year. Ten-year US government bonds temporarily yielded up to 1.6% on Thursday, on Friday afternoon their yield was still 1.47%. At the beginning of the year it was 0.91%. As a result of the rapid development, concerns have been voiced on the stock market about possible sharp price declines - these are finally overdue after the strong recovery in the course of the coronavirus crisis.

And in fact certain parallels can be observed with earlier times, when there was a crash on the stock markets. "Before previous stock market crashes, interest rates also rose and the yield curve became steeper," says financial expert Andreas Homberger. In addition, some bubbles in the financial markets are unmistakable, including, for example, the rapid price development for Bitcoin and some technology stocks. The increasing activity of private investors, the spac phenomenon and the rise in the price of shares in Internet companies that are not posting any profits could also be taken as signs of this.

Is there a boom ahead?

But some things are also different than in the run-up to previous crashes, says Homberger. Monetary policy is much more aggressive than in earlier times and is also combined with historically large fiscal programs. This is tantamount to an experiment never carried out in the post-war period, and the situation is consequently not comparable to the time before the outbreak of the financial crisis in 2008. There is currently a lot to suggest that an economic boom is imminent this year and that companies will experience high profit growth should book. In addition, stocks are still attractive to investors when their valuation is compared with other asset classes such as bonds - provided that interest rates do not continue to rise.

"At such a time, a crash on the stock exchanges is not very plausible," says Homberger. The only thing that could become a problem would be a further sharp rise in interest rates and inflation. "And the current environment is actually very inflationary." There is already a discussion in the USA about whether the fiscal package planned by the new US President Joe Biden with a volume of 1.9 trillion. $ is not too big.

The high debts that have accumulated in recent years also come into play here. In the event of a significant rise in interest rates, many debtors would no longer be able to repay them. “If inflation and interest rates continue to rise significantly, the 'house of cards capital market' starts to falter because all valuations can only be justified with such low interest rates,” says Homberger. Then the prices of stocks and bonds correct at the same time - and do not develop in opposite directions as in the past. At the moment everything depends on the low interest rates.

Australian central bank reacts

In Australia, the Reserve Bank of Australia has already responded with unannounced bond purchases totaling more than $ 2 billion to reassure investors. According to Junius, both representatives of the Federal Reserve and the European Central Bank have clearly signaled that they are not interested in a further rise in interest rates and yields. "If the Federal Reserve goes too far, the rise in interest rates, they may also buy more bonds again or fix the interest rate curve," says Homberger.

Junius is concerned with which sectors of the stock market to prefer in the event of higher interest rates and rising inflation. Energy stocks and financial stocks are in a very good position here. Later in the cycle, when inflation is already near its highs and less driven by oil prices, defensive sectors like staples and utilities become interesting. According to Junius, real estate companies are likely to react negatively to an environment with rising interest rates and higher inflation.