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Cost Of Debt Jets Higher

0321_Debt

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What's going on?

An influential measure of US dollar borrowing costs has spiked sharply in recent weeks, causing concern among some investors – and potentially hiking interest payments for a huge number of companies (and individuals) around the world.

What does this mean?

Weirdly, a certain key short-term interest rate, Libor, has shot much higher than the US Federal Reserve’s target. That usually only happens when the financial system undergoes major stress, like during the 2008 financial crisis – which doesn’t seem to be the case today.


There are a number of less sinister reasons why Libor might be spiking, including the US government recently issuing lots of very short-term bonds (for which investors demand a higher interest rate, due to the larger supply and limited number of buyers). US companies with big overseas operations are also likely buying far fewer of these short-term bonds as they prepare to spend their recently repatriated profits on things like expanding their operations and/or paying a bigger dividend to shareholders.

Why should I care?

For markets: Borrowing costs have gone up – which tends to hurt profits and, ultimately, the economy.

Lots of people and companies borrow money on a “floating” basis, which means that their interest payments depend on a market-driven rate of interest. Since banks borrow lots of money at the Libor rate, it can push up the rates at which they lend to their customers. That means people and companies could end up spending more on interest payments – and less on other things (which is typically negative for the economy). And since US dollars are borrowed around the world, the impact is global.


For you personally: Budgeting for higher interest rates is probably a good idea.

While predicting the future path of interest rates is difficult, it’s eminently possible that the cost of borrowing money will get significantly higher in the coming years (e.g. your mortgage payments may go up noticeably). After almost a decade of ultra-low interest rates, this could come as a shock to many people’s budgets. Consider yourself warned!

Originally posted as part of the Finimize daily email.

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