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The real story behind rising interest rate in 2022

2022 was marked by the disappearance of magic in the financial markets. The performance of all kind of assets declined significantly. According to economist Douglas Porter , BMO (Banque de Montreal), " Stocks and bonds have never fallen together in the same year for 50 years, let alone suffered a fall of more than 10% each." In a nutshell, 2022 was a major blow for investors. Low interest rate that fueled market valuation and surged company profits were seriously hampered during the year; prior interest rate soared considerably, persistently hurting the market. How did high interest rate play a pivotal role in the market drop of 2022? To examine this issue, we will first analyze the impact of low interest rates or expansionary monetary policy on the market and economic more broadly. Then we will focus more specifically on the destructive side effect of tightening monetary policy on the market and economy

The role of low interest rates in national monetary policies

Monetary policy is fundamental for national prosperity. A masterpiece of central bankers can create growth and usher in a golden era. On the flip side, a decision from central bankers can impoverish and spread disaster in a country. In our modern era, central bankers are the anchor of national stability. A low interest rate is associated with healthy business conditions, as macroeconomic theory depicts a low interest rate relieving borrowers and stimulating household desire for consumption. On the company side , it brightens the future outlook and creates better profitability. From stockholder's point of view, a low interest rate is benign because it increases the present value of future earnings. Policymakers use this tactic to boost economy growth after a recession , expand the economy , and fight unemployment. Central bankers employed this tool during the Great Recession in 2007 -2008, when we witnessed the fallout of key economic indicators. For perspective, in December 2008, the unemployment rate in US stood at 7.3%. The conquest of economic health was achieved through a series of measures that mixed conventional monetary policy with other more innovative and efficient monetary tools. The market was flooded with liquidity in order to ease the economic condition. The federal reserve Bank was not willing to repeat its mistake during the Great depression, as a study made by Milton Friedman embodied the Fed's accountability regarding the downturn of the 1930s. As Ben Bernanke said in 2002, " I would like to say to Milton and Anna: regarding the Great Depression. You're right, we did it. We're very sorry. But thanks to you, we won't do it again." The Fed and other major central banks cut rate so that they could revive the economy. The harmonized cut on October 08 , 2008 by the Fed and five central banks epitomizes the sense of international solidary to beat recession, and on this date, the Fed reduced its fund rate by half a percentage point to 1.5%. However conventional monetary policy has limited power to revitalize a sick economy. When the federal fund rate is close to zero or the effective lower bond, this has no real impact on economic fertility. This phenomenon has been named by economist John Maynard Keynes as the liquidity trap, or in our modern era, it's sometimes also called the Japan trap. The fed started its quantitative easing (QE) program to bring to the economy another form of revitalization so desperately needed for the nation's fecundity. Quantitative easing is an unconventional monetary policy that aims to buy mostly long term assets. Unlike conventional monetary policy, the purpose of using QE is to diminish the rate of long term maturity assets. As an illustration, in march 2009, the Fed announced its commitment to spend 750 billion on mortgage- backed securities, 100 billion in Fannie and Freddie debt , and 300 billion in long term treasury shares during the next six months. The combined effect of QE and cut in the short term interest rate, along with other tactics not cited in this article, helped to tackle the Great recession. In June 2009, the recession officially ended and the U.S started its longest glorious era ever recorded, lasting from 2009 to 2020. However , expansionary monetary policy should be used wisely because it could have serious side effects. In fact, a badly controlled expansionary policy can trigger inflation. Central bankers should remember this eternal sentence from Milton Friedman : " Inflation is always and everywhere a monetary phenomenon."

Lesson from the past to bring into the future

World circumstances changed significantly by 2022, and policymakers should adapt their strategies to this changing world. A global diagnosis shows many countries that are facing double digit inflation. The roots of the evil are numerous; for example, the war in Ukraine and the disconnection of supply chains spark rises in inflation. Expansionary monetary policy is also associated with the explosion of this unprecedented rise in price that haven't been seen in the last 40 years. The Fed and many central banks gradually increased their balance through QE from the Great recession to the pandemic era in 2020. From March 2009 to June 2010, the Fed's balance sheet jumped from 1.75 trillion to 2.1 trillion. During the pandemic, the Fed continue to dramatically up its balance sheet to support the economy. On march 15, 2020, The Fed promised to buy 200 billion in government guaranteed mortgage - backed securities and 500 billion in treasury securities during the upcoming month. For this reason, Stanley Druckenmiller, one of the greatest investor of our era , blamed the Fed during the Alpha investor summit in 2022: " If you remember, the Fed did 2 trillion in QE after vaccine confirmation. And after the time I went on, you had the strongest momentum in employment in history on a rate of change basis. At the same time their partner in crime, the administration, was doing more stimulus, again, post vaccine, after it was clear emergency measure weren't needed, than we did in the entire great financial crisis."


Inflation rate in % in November 2022





United Kingdom












Source: Bloomberg

Inflation is a form of economical genocide that destroy the wealth of entire nations. Fixed income earners during inflation experience a sharp reduction of their purchasing power, and companies are less attracted to invest. Ernest Hemingway acknowledged the harmful strength of inflation many decades ago: " The first panacea for a mismanaged nation is inflation, the second is war. Both bring temporary prosperity; both bring permanent ruin. But both are the refuge of political and economic opportunists." History is an incredible teacher, and the situation we are living through today is similar to what our predecessors lived through during the 1970S. Our parents confronted painful inflation due to macroeconomic policy mismanagement and oil shock. Inflation hit 13.3% in 1979 and 12.5% in 1980. Since the war era, when inflation climbed to all new heights, the U.S has never faced such a calamity. To cool the rising prices in 1970s, the chairman of the federal reserve Volcker made a courageous decision: He hiked the interest rate to 20%. Inflation slowed down, plummeting to 4% by 1980. However the victory against inflation was achieved only with serious damage. The recession that followed and the loss in output exemplify the devastating effect that tightening monetary policy can have. The stock market crashed and millions of people lost their jobs due to the contractionary monetary policy. This episode serves as lesson that when tightening is used too aggressively to combat inflation, there are negative side effects, even though it is a type of cure for worsened inflation by tightening a slow economy via reducing credit availability and capital investment. Inflation in 2022 became a top concern for a generation addicted to price stability and easy money. Central Bankers increased the interest rate largely in order to curb inflation. In the U.S, Jerome Powell and his team raised the rate seven time over the course of this one year. In December, the bank of Canada ruled by Tiff Macklem likewise increased their key lending rate for the seventh time, and the rate grew by 50 basis points. Emerging market economy central banks have increased the rate 93 times this year to elevate their benchmark by a total of 7425 basis point.


Hike in % on June 20, 2022











South Africa


Saudi Arabia


Source: Mckinsey & Company , " How inflation is flipping the economic script, in seven charts"

The bear market that occurred during the year is strongly correlated to the tightening monetary policy used by central bankers worldwide so that they could stop this new era of inflation before it got completely out of control. Contractionary monetary policy is inflicting harm on the economy as well. Vulnerable households are experiencing chaos and storms as mortgage and credit card rates explode. While the labor market has shown some resiliency overall, some industries have been penalized by the heavy cost of the high interest rate. Throughout the year, 90,000 tech workers were laid off in the U.S. In October 2022, Elon Musk said, “Regarding Twitter’s reduction in force, unfortunately there is no choice when the company is losing over 4M/day.”

2022 was such a challenging year for policymakers because inflation became a foremost national threat like it was in the 1970s. The dilemma now facing central bankers is twofold. On the one hand, they must bring down inflation in order to maintain Volcker’s legacy. Volcker, who waged war on inflation, built the reputation of the Fed as an inflation fighter by demolishing it. On the other hand, central bankers must also win that noble war without ruining the economy or leading countries toward recession. Between 1994-1996, Alan Greenspan cooled inflation without a considerable shortfall in economic output. Can central bankers in 2022 achieve a new soft landing? Investors experienced anxiety during the year since all assets performed poorly. There are alarming signs that in 2023, major economies may undergo a recession. In June 2022, the Royal Bank of Canada (RBC) made some apocalyptic prophecies regarding 2023. According to RBC economists, Canada’s economy will contract by an annualized 0.5% in the second and third quarters of 2023, while the unemployment rate will rise to 6.6%. Despite these fearful forecasts, can we expect perfect weather in 2023?

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