The Future Of Interest Rates

The Future Of Interest Rates

over 3 years ago3 mins

Mentioned in story

A key interest rate that several others have been based on is set to disappear next year. So this week, we’re looking at what’s taking its place around the world – and, more importantly, how the replacements might impact you.

⏰ Recap

  • The London Interbank Offered Rate – a.k.a. LIBOR – has long been used to set several other interest rates
  • But badly behaved bankers were (surprise, surprise) caught manipulating LIBOR, which ultimately led to its demise
  • Since the coronavirus pandemic struck, key interest rates around the world have been reduced to record lows

✍️ Connecting The Dots

For the last 50 years or so, LIBOR’s helped determine interest rates across the globe that, collectively, affect the cost of $300 trillion worth of debt – everything from simple mortgages to complex collateralized debt obligations. LIBOR was calculated based on a daily survey, in which banks were asked how much they’d charge one another to borrow money for a short period. But after it emerged that some of them had colluded to manipulate LIBOR for profit, policymakers around the world stepped in to reduce their countries’ reliance on the controversial rate. And now that it’s getting officially phased out next year, those countries are going to need an alternative.

There are a few to choose from. The US’s central bank, for its part, is keen to use the Secured Overnight Financing Rate – or SOFR – which helps determine the interest rates of roughly $200 trillion of assets. It’s based on real transactions as opposed to bank surveys: specifically, it’s the rate charged on government bond-secured overnight lending. That means that if the borrower defaults, the lender can sell the bonds to get repaid.

Europe, on the other hand, seems to favor “Euribor”, which underpins some $211 trillion of assets. It’s partly calculated based on actual bank transactions, which makes it a bit more rigorous than surveys. As for the UK, it has a mind to go with the 23-year-old Sterling Overnight Index Average (Sonia), which values about $40 trillion worth of trades each year. It’s looked after by the Bank of England, and is pretty similar to the US’s SOFR.

🥡 Takeaways

Lots of people and companies borrow money on a “floating” basis, which means their interest payments depend on the rates chosen by commercial banks. And since those banks borrowed lots of money at the LIBOR – and now SOFR, Euribor, and Sonia – rate, their own rates might rise too. That means individuals and companies could end up spending more on interest payments and less on other things – which is typically negative for the economy. And since this is happening all around the world, the impact is, y’know… global.

Predicting the future path of interest rates is tricky at the best of times, but it’s even trickier now: you’d probably need to be an expert in coronavirus vaccines, and have the inside track on when they’ll arrive. But it’s eminently possible that the cost of borrowing money will get significantly higher in the next few years, and that your mortgage payments will go up noticeably. After years of ultra-low interest rates – and this year’s record lows – that could come as a shock to your budget.

🎯 Also On Our Radar

Apple made history last week by becoming the first US company to reach a $2 trillion valuation, while electric carmaker Tesla’s stock also marched higher. And what do the two have in common? Simple: both have recently announced stock splits. If you’re wondering whether Apple can keep this up – and if its stock split has opened an investment door you want to enter – you’re not alone. Luckily, we have a Pack that’ll help you answer that very question.

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