He argues that after the approximately 15-year period of low interest rates since 2008, the financial system has become completely centered around low interest rates. If interest rates remain high for an extended period of time, many of the business models, investment ideas and hedging strategies that support the economy will stall.
The unrest is already happening. Liability-led investment (LDI) strategies have collapsed, forcing pension funds to rapidly sell bonds in the wake of the 2022 mini-budget.
“Everyone's portfolio is set up for completely different interest rate structures. When you tighten things up too quickly like this, bad things happen,” says Mortimer Lee, a Brit based in New York.
In his view, the original sin was central banks doing too much quantitative easing (QE) during the pandemic.
The Bank of England has significantly increased its bond purchases, increasing its balance sheet from £435bn to £875bn by the end of 2021. The European Central Bank and the US Federal Reserve also launched unprecedented stimulus measures.
“They've gone crazy because of COVID,” Mortimer-Lee said. “While COVID-19 was temporary, they treated their balance sheets as permanent. We have done much more against the virus.
“We're going to cut interest rates to zero and we're going to buy up every bond that the government issues. That's why government deficits in the UK and the US are so outrageously high, because the money was free. It's like giving a kid a credit card and saying, 'Whatever you like. It's like saying, “Please use only that.” And that's what the government did. ”
The deadline for repaying the loan is now approaching.
The Bank of England's argument is that much of what we know now is only known with hindsight.
Ben Broadbent, the central bank's deputy governor, has claimed that officials are concerned that the end of the coronavirus furlough scheme could lead to a surge in job losses.
The Monetary Policy Committee waited to tighten policy until it was clear there would be no surge in layoffs.
By then, inflation was already rising rapidly, forcing the central bank to raise interest rates extremely quickly to curb price increases, from 0.1% in December 2021 to 5.25% now.
If the Fed or the European Central Bank were to do the same, Mortimer-Lee said, the results would only get ugly.
U.S. companies will face a “nightmare” next year as cheap debt expires and will need to be refinanced at higher costs.
“The housing market is a disaster waiting to happen,” he said, arguing that households were borrowing as if interest rates would continue to be low.
If he's right, why have we seen only limited impact from higher borrowing costs so far?
