What do peak interest rates mean for charity finances?

Charities must review their investment strategy as interest rates peak. But rates are likely to remain higher for longer than many in the market think.

| 4 min read

Rising interest rates have a significant impact on the investment landscape. As we saw last year, sharp increases in interest rates to control inflation are usually a negative for stock markets. Interest rates are increased to cool down an economy and reduce demand, so suggest a period of slowing economic activity will follow, hitting company profits. It also increases the cost of borrowing, so companies that rely on debt funding are often particularly hard hit.

When it comes to bonds, higher interest rates cause a fall in their prices. Assets with fixed, long-term cash flows tend to perform poorly when inflation is rising because the purchasing power of those future cash flows will fall over time. So, with fixed-income securities’ prices moving contrary to interest rates, the best time to invest in these securities is at the peak of an inflation cycle, when interest rates are high and fixed-income securities trade at low prices.

Interest rates reach summit?

We are now moving closer to the peak in the interest rate cycle. As interest rates approach their highest point, longer- term fixed income assets become more attractive, as they will benefit from any stabilisation in the economy and then the subsequent fall in interest rates. In equity markets, peaking interest rates mean that the more cyclical sectors become more attractive – and investors can consider rotating out of industries such as banking which tend to perform well in a rising interest rate environment.

However, it is still not clear when interest rates will peak – and the market is split on exactly when they will start to fall. Many in the markets have been over-optimistic about when the US Federal Reserve (Fed), the most important central bank in the world, will start to cut interest rates. In May, futures markets were pricing in three of four interest rate cuts before the end of 2023. However, as inflation remained stubbornly high, this optimistic outlook has been tempered.

Fed policymakers have been consistent in their view that tackling inflation remains a high priority – implying the central bank will continue with its tough stance. The consistent message from the Fed is that it has no plans to chip away at rates while inflation remains far above its target. The way investors’ views on the interest rate outlook have been shifting rapidly underlines the state of intense uncertainty over where markets will head next, particularly amongst professional market participants.

Although the expectations of a recession have eased, or at least been pushed further down the track, a sharp contraction remains a very real possibility. At this stage, if a recession does emerge, it is likely to be shallow as the employment market remains particularly strong and is providing support for the overall economy.

Inflationary pressures

Inflation in the UK is proving particularly stubborn, consistently coming in above expectations and in Europe remains too high for the European Central Bank. This means there is likely to be further rate rises over the summer before a period when rates are held high to bring inflation firmly back under control.

Although major central banks are at different points in their cycles, they appear to be on the same path to a peak and then an extended pause before they start their easing cycles.
However, investors should not be looking for a return to the level of interest rates ushered in after the financial crisis in 2007/8 and maintained during the Covid-19 pandemic. The period of ultra- low interest rates is over. Charles Stanley does not expect the Federal Reserve to cut interest rates any time soon. We are not amongst the optimists who think a significant change in policy by central banks is at hand. Nevertheless, we are prepared for its market implications when it does.

The period of ultra-low interest rates is over. Charles Stanley does not expect the Federal Reserve to cut interest rates any time soon...

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