Why interest rate cycles matter, a LOT!

Why interest rate cycles matter, a LOT!

Summarized version for now, I’ll try to enhance it more in the future:

 Increasing or high interest rate phase:

  • Costs for corporate investments go up or are higher
    • reducing their IRR,
    • increasing payback periods,
    • or just making them unprofitable
    • a lot of corporate investments get shelved during a period of high interest rates
  • Costs to buy house go up
    • Higher interest rates = Higher monthly payments
    • Higher revenue required to buy a house of same price
    • Lower home affordability
    • Less houses built, or lower priced houses built due to market conditions
    • Lower demand drives down house prices
  • Borrowing costs to invest in stock market go up
    • Lower demand decreases stock prices
  • Fixed income markets become more interesting than stock markets
    • Less risk, guaranteed returns
    • Stock prices go down
  • Options pricing affected, longer term options more expensive (black scholes formula)

Decreasing or low interest rate phase:

  • Low costs for corporate investments
    • Higher IRR
    • Lower payback periods
  • House payments are lower
    • Same revenue buys a better house
    • Higher demand drives house prices up
  • Cheaper to borrow money to invest in stock market
    • Higher demand increases stock prices
  • Fixed income markets become unattractive
    • Quest for returns turn to the stock market driving prices up
  • Options pricing lowers