Impact of Interest Rate Adjustments

Interest Rate Risk: Why It Matters Even When Rates Are Stable Interest rate risk often hides in plain sight. When rates are volatile, it is top of mind. But when they stabilise — or appear to — many assume the worst is over. This assumption can be costly. Understanding interest rate risk requires more than tracking central bank decisions. It requires recognising that repricing mismatches on the balance sheet do not disappear just because the market quietens. In fact, those mismatches often deepen during calm periods, masked by stable net interest margins or temporary accounting gains. There are two main types of interest rate risk that every bank must manage: Repricing Risk (or Gap Risk): This arises when assets and liabilities reprice at different times or on different terms. For example, fixed-rate mortgages funded by short-term customer deposits create exposure if rates rise — the funding cost increases, but the asset yield does not. Basis Risk: This emerges when two instruments reprice from different benchmarks. For instance, a bank might hedge SONIA-based assets with 3M LIBOR derivatives (historically) or hedge variable-rate loans using swaps indexed to a different benchmark than the underlying cashflows. These risks are rarely symmetrical. A bank might be positioned to benefit in one scenario but be significantly exposed in another. And while earnings-at-risk models can show the short-term impact, economic value measures often reveal the longer-term story — particularly for banks with large maturity mismatches. So why does this matter today? Because balance sheet positioning over the past five years has shifted dramatically. In the ultra-low rate environment, many institutions leaned into fixed-rate lending, chasing margin through duration. Now, as central banks hold at higher levels or begin to ease, the embedded rate sensitivity in those positions becomes more apparent. Here are three reasons interest rate risk still deserves attention: 1. Lagged Effects: Interest rate risk is often slow to materialise. Hedging costs roll off, floors expire, and behavioural assumptions (like early repayments) shift when rates stay high for longer than expected. 2. Policy Uncertainty: Central banks are not done yet. Rate cuts may not come as quickly or deeply as markets expect. Any surprises — especially on inflation or employment — can quickly change the path and catch institutions off guard. 3. Capital and Liquidity Impact: Earnings volatility affects capital. Rate risk also interacts with liquidity risk, as seen in 2023 when deposit outflows coincided with unrealised losses on securities portfolios. These are not isolated risks. They compound. Managing interest rate risk is not about predicting rates. It is about being prepared for multiple scenarios. This includes regularly stress testing key assumptions, assessing both short-term and long-term exposures, and ensuring risk appetite aligns with strategy, even when rates are steady.

All eyes are on the Fed’s anticipated rate cut this month, the most significant event shaping market sentiment. We’ve been hearing a lot of concerns that rate cuts signal an economic slowdown and could turn into a negative event for the markets. But is that really the case? In fact, the impact of rate cuts is highly contextual. According to a recent report by the Franklin Templeton Institute, history shows that the effect of rate cuts varies greatly depending on the economic conditions at the time. 📉 𝐑𝐚𝐭𝐞 𝐂𝐮𝐭𝐬 𝐢𝐧 𝐑𝐞𝐜𝐞𝐬𝐬𝐢𝐨𝐧𝐬 𝐯𝐬. 𝐄𝐱𝐩𝐚𝐧𝐬𝐢𝐨𝐧𝐬: • 𝐑𝐞𝐜𝐞𝐬𝐬𝐢𝐨𝐧𝐚𝐫𝐲 𝐑𝐚𝐭𝐞 𝐂𝐮𝐭𝐬: During recessions, rate cuts can initially cause a dip in equity markets. In these periods, equities have historically seen short-term declines, with Treasuries often outperforming as a safe haven. It’s a defensive play, indicating the markets brace for further economic deterioration. • 𝐄𝐱𝐩𝐚𝐧𝐬𝐢𝐨𝐧𝐚𝐫𝐲 𝐑𝐚𝐭𝐞 𝐂𝐮𝐭𝐬: However, when rate cuts occur during economic expansions, the story is entirely different. The report shows that equities tend to rally significantly after rate cuts in expansions, with growth and small-cap stocks leading the way. Historically, the S&P 500, Nasdaq, and Russell indices have all performed exceptionally well following expansionary cuts, with minimal drawdowns. 📊 𝐊𝐞𝐲 𝐒𝐭𝐚𝐭𝐬: • During recessions, equities declined by an average of 4.96% in the first three months post-rate cut, but then rebounded over the next 6-12 months. • During expansions, equities often surged, with the Nasdaq gaining 25.33% over the year following the first rate cut, while the S&P 500 rose 16.66%. So the big question becomes: Has the recent rate hike cycle slowed growth enough to push us toward a recession, or do we still have room for economic expansion? This is the critical factor that will determine whether the upcoming rate cut will spark a bull run or trigger a market pullback. 📈 𝐖𝐡𝐚𝐭 𝐇𝐚𝐩𝐩𝐞𝐧𝐬 𝐍𝐞𝐱𝐭? Historically, during rate-cutting cycles, value stocks perform well initially, but growth stocks take over as the market gains momentum. That’s exactly what we’re seeing right now—growth stocks have been outperforming, a positive sign that the economy could still have room to grow. More than anything, what will truly define the trajectory of the markets is how well the Fed manages to navigate the “soft landing”—balancing the slowing inflation without stalling economic growth. This delicate balance will be crucial in determining whether the upcoming rate cut sparks growth or reinforces recession fears. #MarketInsights #RateCuts #Investing #FedPolicy #GrowthStocks #EconomicExpansion #StockMarket #Treasuries

A coaching client just asked me, "𝗧𝗵𝗲 𝗙𝗲𝗱 𝗷𝘂𝘀𝘁 𝗰𝘂𝘁 𝗿𝗮𝘁𝗲𝘀 𝘁𝗼 𝟬.𝟱%. 𝗪𝗵𝗮𝘁 𝗱𝗼𝗲𝘀 𝘁𝗵𝗶𝘀 𝗺𝗲𝗮𝗻 𝗳𝗼𝗿 𝗺𝘆 𝗰𝗮𝗿𝗲𝗲𝗿?" 𝘐𝘵 𝘸𝘢𝘴 𝘢 𝘸𝘢𝘬𝘦-𝘶𝘱 𝘤𝘢𝘭𝘭. I realized that many professionals were unsure how economic policies affect their job prospects. 𝗧𝗵𝗲𝘆 𝘄𝗲𝗿𝗲 𝗺𝗶𝘀𝘀𝗶𝗻𝗴 𝗼𝘂𝘁 𝗼𝗻 𝗼𝗽𝗽𝗼𝗿𝘁𝘂𝗻𝗶𝘁𝗶𝗲𝘀 𝘀𝗶𝗺𝗽𝗹𝘆 𝗯𝗲𝗰𝗮𝘂𝘀𝗲 𝘁𝗵𝗲𝘆 𝗱𝗶𝗱𝗻'𝘁 𝘂𝗻𝗱𝗲𝗿𝘀𝘁𝗮𝗻𝗱 𝘁𝗵𝗲 𝗶𝗺𝗽𝗹𝗶𝗰𝗮𝘁𝗶𝗼𝗻𝘀 𝗼𝗳 𝘁𝗵𝗲𝘀𝗲 𝗰𝗵𝗮𝗻𝗴𝗲𝘀. I didn't want this to happen to anyone else. So, as a career strategist and former private wealth manager, I dove deep into understanding how interest rate cuts affect the job market and leveraged my insider knowledge of industry trends. I discovered that this rate cut could have significant impacts. Job creation, wage growth, sector shifts – they all matter. I decided to share these insights with you.Here's what you need to know about how the Fed's 0.5% rate cut could affect your career: - Potential increase in job opportunities - Possible upward pressure on wages - Preservation of recent labor market gains - Varying effects across different sectors - Improved conditions for career transitions 𝗕𝘆 𝘂𝗻𝗱𝗲𝗿𝘀𝘁𝗮𝗻𝗱𝗶𝗻𝗴 𝘁𝗵𝗲𝘀𝗲 𝗶𝗺𝗽𝗮𝗰𝘁𝘀, 𝘆𝗼𝘂'𝗹𝗹 𝗯𝗲 𝗯𝗲𝘁𝘁𝗲𝗿 𝗽𝗼𝘀𝗶𝘁𝗶𝗼𝗻𝗲𝗱 𝘁𝗼 𝗺𝗮𝗸𝗲 𝗶𝗻𝗳𝗼𝗿𝗺𝗲𝗱 𝗰𝗮𝗿𝗲𝗲𝗿 𝗱𝗲𝗰𝗶𝘀𝗶𝗼𝗻𝘀. 𝗕𝗲𝗰𝗮𝘂𝘀𝗲 𝗲𝘃𝗲𝗿𝘆𝗼𝗻𝗲 𝗱𝗲𝘀𝗲𝗿𝘃𝗲𝘀 𝘁𝗼 𝗯𝗲 𝗽𝗿𝗲𝗽𝗮𝗿𝗲𝗱. And everyone deserves a chance to thrive in changing economic conditions. Remember, economic shifts create both challenges and opportunities. With the right knowledge, you can navigate these changes successfully. 𝐖𝐡𝐚𝐭 𝐚𝐫𝐞 𝐲𝐨𝐮𝐫 𝐭𝐡𝐨𝐮𝐠𝐡𝐭𝐬 𝐨𝐧 𝐭𝐡𝐢𝐬 𝐫𝐚𝐭𝐞 𝐜𝐮𝐭? How do you think it will affect your industry or career plans? #FederalReserve hashtag#JobMarket #EconomicPolicy #CareerDevelopment #ProfessionalGrowth

Residential real estate interest groups are clamoring for the Fed to cut interest rates. But does the policy rate matter to long-term interest rates? The answer is kind of, and it takes a while. Let's start by looking at the relationship between the Federal Funds Rate and the 10-year Treasury rate going back to 2000. It is pretty clear that there is a relationship, but it is not a tight one. Note that the 10-year did fall between 2000 and 2021, but the Federal Funds Rate moved around a lot more than the 10-year before 2008, and the 10-year moved around a lot more than the Federal Funds Rate in the teens. The 10-year also led the Federal Funds Rate between 2022 and 2023ish. When we summarize this relationship in a regression, we find that over the long run, a one percentage point change in the Federal Funds Rate produces a 46 basis point change in the 10-year, meaning that eventually a 50 basis point cut would lead to about a 23 basis point reduction in the 10-year. That is certainly not nothing. But it takes a while. I show another regression that looks at what happens to the 10-year Treasury one month after a cut in the Federal Funds rate. The answer is: not much. I separate the effects of negative and positive cuts. The impact of a negative cut is barely significant and is also small (a 50 bp cut would produce about a 5 bp cut in 10-years, and the estimate lacks precision). The impact of a rate rise on the 10-year after a month is non-existent. So for those who think a Fed rate cut will reinvigorate the housing market, don't hold your breath.

Day 26: "The Role of Asset-Liability Management (ALM) in Navigating Rising Interest Rate Environments". 🌐 🚀 ⌛ In today’s dynamic economic landscape, rising interest rates pose significant challenges for financial institutions. With central banks around the world tightening monetary policy to combat inflation, banks, insurers, and other financial entities are facing increasing pressure to manage the risks associated with fluctuating rates. Asset-Liability Management (ALM) plays a pivotal role in ensuring financial stability and optimizing performance during such periods of uncertainty. Why Rising Interest Rates Matter ⚡ 🌎 📊 Rising interest rates affect the balance sheets of financial institutions in several critical ways: 1. Interest Rate Risk: 🏦 🎢 Higher rates impact the value of assets and liabilities differently, leading to mismatches that can reduce profitability or equity value. 2. Liquidity Risk: 🏦 🎢 Maintaining sufficient liquidity becomes more challenging as borrowing costs increase, and customer behavior changes. 3. Margin Pressure: 🏦 🎢 A narrowing of net interest margins (NIM) may occur if liabilities reprice faster than assets. To navigate these challenges effectively, robust ALM strategies are indispensable. Key Functions of ALM in a Rising Rate Environment⚡ 🌎 📊 1. Managing Interest Rate Risk 🏦 🎢 ALM teams employ various strategies to assess and mitigate interest rate risk: Gap Analysis: 💵 🌎 Identifies mismatches between asset and liability maturities to evaluate sensitivity to rate changes. Duration and Convexity Matching: 💵 🌎 Aligns the durations of assets and liabilities to minimize the impact of rate shifts. Interest Rate Hedging: 💵 🌎 Utilizes derivatives such as interest rate swaps, futures, and caps to hedge against adverse movements in rates. 2. Scenario and Stress Testing 🏦 🎢 ALM leverages scenario analysis to model the impact of rate changes across a range of potential market conditions. Stress testing prepares institutions for extreme scenarios, such as sharp and unexpected rate hikes, ensuring they remain resilient under adverse conditions. 3. Optimizing Liquidity Management 🏦 🎢 In a rising rate environment, ALM ensures institutions maintain adequate liquidity. 4. Capital Management 🏦 🎢 Rising rates can impact regulatory capital ratios, especially for institutions holding long-duration fixed-income assets. ALM helps optimize capital allocation and ensures compliance with capital adequacy requirements. Case Study: ALM in Action⚡ 🌎 📊 Scenario: A mid-sized bank faces a rising rate environment, with liabilities (deposits) repricing faster than assets (fixed-rate loans). Outcome: The bank mitigates margin compression, maintains liquidity, and ensures regulatory compliance, safeguarding its profitability. #InterestRates #Markets #MarketRisk #Risk #Riskmanagement #Traded #Quant #Finance #QuantitativeFinance #ALM #Liquidity #Rates

So the RBI has cut repo rate by 50 bps to 5.5%. What does this really mean for you? This affects us all, from EMIs, saving for the future, running a business, or just managing household expenses. Here’s how it plays out, - Loan EMIs get easier When the repo rate drops, banks can borrow money from the RBI at a cheaper rate. This usually means banks will reduce the interest rates on home, car, and personal loans. For you, this could mean your monthly EMIs go down. For example, if you have a ₹50 lakh home loan, even a small rate cut can save you a bunch. New borrowers will also find it easier to get loans at lower rates, making big purchases like homes or cars more affordable. - Fixed Deposit returns may drop While borrowers celebrate, savers or depositors will feel the pinch. As banks lower lending rates, they also tend to reduce the interest rates on FDs and savings accounts. If you rely on interest income, your returns could decrease. It might be a good idea to lock in current FD rates before they fall further. - Boost for businesses and jobs Cheaper loans aren’t just for individuals. Small businesses and startups also benefit, as they can borrow at lower rates to expand, buy equipment, or hire more people. This can help create jobs and support local economies, especially in sectors like real estate, auto, and small businesses. - Encourages spending Lower interest rates mean people and businesses are more likely to borrow and spend, rather than save. This increased spending helps boost demand for goods and services, which is good for the overall economy. Sectors like housing and automobiles often see a pick-up in demand after a repo rate cut, as more people can afford to buy homes or vehicles. - Inflation and Rupee impact The RBI usually cuts rates when inflation is under control, aiming to support growth. However, lower rates can sometimes weaken the rupee slightly, as foreign investors might look for better returns elsewhere. So this is more like RBI's gentle push to the economy, making it easier for people to borrow, spend, and invest, while savers might need to look for better ways to grow their money. For anyone tracking the equity markets, it is good news (Nifty is up 0.75% since this was announced). This increased spending and investment can spur economic growth. As a result, equity markets often react positively, especially in the short term, due to improved business prospects and higher expected earnings. (Caveat being the banks passing on lower rates to borrowers)

This chart serves as a compelling illustration that we have not yet experienced the impact of tighter financial conditions filtering through the system. Despite the recent increase in mortgage rates, effective interest rates for most individuals remain at historically low levels. Corporations are in a similar position, but bear in mind: We are on the verge of witnessing a substantial surge in the cost of debt as we brace for a significant wave of debt refinancing in the next 12 to 24 months. Sovereign institutions are also facing a comparable scenario. The US federal debt, in particular, will need to refinance nearly 50% of its total debt in the next three years at substantially higher interest rates.

With fixed interest rates up ~70 bps over the last two months, it's important to understand how higher rates impact loan proceeds. I pulled together a chart illustrating that for every 25-bp increase in interest rate, your loan proceeds decrease by approximately 2.6%. Have rates gone up 50 basis points since you last updated your model? Then your loan amount will be ~5.2% lower. The example in the chart uses a $2M NOI, but the same relationship exists regardless of NOI. For people reading this who may be unfamiliar with the terminology: Loan Constant = Your annual debt service divided by the loan amount. It takes into account the amortization, so if a loan is interest-only, then your interest rate and your loan constant are the same. DSCR = Debt Service Coverage Ratio. This is your NOI divided by debt service. Most lenders typically want the NOI to be at least 1.25x the annual debt service. If this explanation may be helpful for any of your connections, please Like and Repost. Thank you!

This year, the interest rates in Canada have significantly increased, causing a significant impact on homeowners with variable mortgages. For example, individuals who purchased a house when the interest rate was 1.5% and have a variable mortgage are now experiencing a 60% increase in their monthly mortgage payments. For instance, a house that was purchased for $700,000 with a 10% down payment had a monthly payment of $2,500 in 2021. However, due to the increased interest rates, the monthly payment has jumped to $4,100, reflecting a 65% increase. Similarly, a house valued at $900,000 with a 10% down payment and a previous mortgage payment of $3,300 per month has now increased to $5,300, representing a 60% increase. One of the concerning aspects is that a significant portion of these increased payments is allocated towards interest, which can be disheartening for homeowners. It is crucial for individuals considering home ownership or those with variable mortgages to carefully assess the potential impact of rising interest rates on their monthly payments and overall financial situation. The opinions expressed in my posts are solely my own and do not represent the viewpoints of my employer, clients, or customers. #canada #interestrates #payments #mortgage

RBI's repo rate cuts have seen only partial transmission thus far: Foreign Banks cut lending rates most (34 bps on outstanding loans), #PSBs & Pvt Banks less (10-19 bps) esp on fresh loans & deposits. Customers of the banking system need to wait longer for the benefits of RBI's rate cuts to accrue to them. In fact, Pvt Banks raised fresh deposit rates by 20 bps The transmission of interest rate cuts by banks has been low despite RBI cutting rates with alacrity due to several factors including: - Liquidity: Excess liquidity in the system can reduce banks' reliance on RBI funding, diminishing the impact of rate cuts. - Risk aversion: Banks may be cautious in lending, prioritizing safer investments. - There are also inbuilt rigidities in bank asset-liabilities that affect transmission of rate cuts : 1. Sticky deposits: Banks often don't pass on rate cuts to depositors to maintain deposits and avoid losing customers. 2. Existing loan portfolios: Fixed-rate loans or long-term loans with fixed interest rates limit immediate transmission. 3. Asset-liability mismatch: Banks' assets (loans) and liabilities (deposits) have different interest rate sensitivities. However, in contrast, when policy rates rise, transmission is faster as - Banks quickly pass on higher rates to borrowers. - Depositors expect higher returns. #monetarypolicy #rbi #interestrates #transmission #banks #deposits #lending