What will the future bring: Mitigating the impact of central bank rate changes

With global inflation predicted to grow from 4.7% in 2021 to around 9% by the end of 2022,ⁱ  the world’s central banks have taken swift action aimed at beating back inflation to a modest 2% growth. In the United States, a flurry of rate hikes throughout 2022, have added up to the steepest the country has seen since the 1980s.ⁱⁱ Central banks across Asia, Canada and Europe have initiated similar increases,ⁱⁱⁱ  and promise additional rate hikes before the year’s end.^iv 

However, several economic experts predict that actions taken by central banks in 2022, could drive the economy into recessionary territory. A third-quarter Bankrate poll indicated that 65% of economists expect a recession by the end of 2023.^v

As the economy slows, experts also predict that central banks will begin to ease monetary policy. Morningstar, for example, predicts that federal funds rates will dip to 3% in 2023 as the inflation begins a steep plummet to 1.7% by 2026.^vi  Economic experts across Europe anticipate similar actions by the European Central Bank in 2023, as record inflation and Europe’s energy crisis continue to encourage rising prices.^vii

Fluctuating interest rates, combined with a slumbering economy, can wreak havoc across equity markets. The results reach directly into banking treasury departments, dimming the lights on corporate and institutional profitability, while increasing risk for the institution.  

As the bank treasury seeks to meet the investment needs of their clients, digitalization and cloud-based technologies are making it possible to institute a comprehensive risk, governance, and compliance framework within the treasury, facilitating rapid action in the face of uncertainty.

Impact of central bank rate hikes on investment outcomes

The mere mention of a central bank rate hike can cause panic across equity markets and send the value of investments plummeting. For example, the Dow fell more than 400 points in October upon an announcement by the Federal Reserve chair, stating that interest rate hikes would continue through the foreseeable future.^viii 

Beyond market fluctuations, rising and falling interest rates exert real-world pressures on investments, such as bonds. When interest rates rise, bond prices fall, while the inverse is true as interest rates climb. The current uncertainty about how the world’s central banks will respond over the next year increases the complexity banking treasuries face, by making it more difficult to estimate bond performance.

Currency fluctuations are another challenge. In October, the Euro, British Pound and Yen all fell below the dollar, following Central Bank decisions to raise interest rates.^ix  Even a minor decline in currency value can impact the return on foreign investments, and must be weighed as treasuries estimate risk and facilitate trades.

Of course, one of the biggest worries when it comes to rate hikes is the risk of recession. During extreme economic slowdowns, the price of stocks typically plummets and then rises again as the economy begins to recover. For example, the S&P 500 has historically bottomed out approximately 4 months before the end of a recession, before initiating a recovery phase.^x

Amid periods of heightened volatility, predicting performance outcomes and identifying risks becomes a bigger challenge for banking treasury departments, and one that is increasingly being addressed through adoption of targeted technologies.

Technology tackles risk

Facing uncertain market conditions calls for banks to establish a comprehensive risk, governance, and compliance framework within the treasury. Leading technology trading solutions facilitate a seamless flow of activity from back-office accounting, clearing and settlement, through front-office functions.

The consistent data flow across all parties facilitates seamless trading activity, by supporting a real time view of interest rates positions, currency valuations, trading exposures and other factors critical to assessing risk and taking action. Analytics are also key components of treasury technology today, providing on-the-fly data aggregation, trade drill down and analysis as well as onboard VaR, back testing and stress testing capabilities.

By automating this world of data analysis , treasury professionals receive comprehensive insights on credit, market and liquidity risk, as well as the means to better manage the exposure they face. Leading edge capabilities offer automated guidance on the hedging products that are best suited to protect customer and institution positions, but integrating new capabilities into existing cores has traditionally been a long and arduous process.

Today’s technology expands the interoperability between core treasury solutions and new fintech offerings, utilizing APIs to seamlessly connect new products. By utilizing APIs, institutions are shortening the product adoption lifecycle and gaining agility through faster time to market of integrated capabilities.

As the world’s central banks continue to adjust interest rates in the face of rising inflation, platform-based technology makes it easier for financial institutions to adopt the technology they need to realize market-leading insights and more accurate trading, faster. The result is an end-to-end modernization of the treasury department with a comprehensive risk and trading framework, designed to help banks manage uncertainty.

_{ⁱ  “World Economic Outlook.” International Monetary Fund, Nov. 7, 2022. Web.
ⁱⁱ  Sarah Foster. “How Much Will the Red Raise Interest Rates in 2022? Here’s What Experts Are Saying.” Bankrate, Nov. 3, 2022. Web.
ⁱⁱⁱ  Judy Woodruff. “As Fed Raises Interest Rates to Combat Inflation, Central Banks Around the World Follow.” PBS. PBS News Hour, Sep. 21, 2022. Web.
^iv  Francesco Canepa and Balazsw Koranyi. “ECB Eyes Jumbo Rate Hike to Fight Inflation Even as Debtors Suffer.” Reuters, Sep. 29, 2022. Web.
^v  Sarah Foster. “Survey: Odds of a U.S. Recession by Mid-2024 Now Hit 65%.” Bankrate, Oct. 5, 2022. Web.
^vi  Preston Caldwell. “Why We Expect the Fed to Cut Interest Rates in 2023.” Morningstar, Oct. 21, 2022. Web.
^vii  Jana Randow. “Most Banks See ECB Slowing Rate Hikes, Reaching Peak Early 2023.” Bloomberg, Oct. 28, 2022. Web.
^viii  Paul R. La Monica and Nicole Goodkind. “Stocks Tumble After Fed Signals Rate Hikes Are Here to Stay.” CNN. CNN Business, Nov. 2, 2022. Web.
^ix  “Euro Falls Against the Dollar After ECB Rate Hike, U.S. Data.” CNBC, Oct. 27, 2022. Web.
^x  Sergei Klebnikov. “How Does the Market Perform During an Economic Recession? You May Be Surprised.” Forbes, Jun. 2, 2022. Web.}