The Fed is on the verge of announcing a 50 basis point hike in its benchmark interest rate and is expected to announce a series of similar moves later this year that will take the federal funds rate from near zero to at least 2.5 percent by the end would coincide with the start of “quantitative tightening,” or a reduction in the $9 trillion ($12.7 trillion) pile of bonds and mortgages it has amassed since 2008 to inject ultra-cheap liquidity into the financial system .
This will be a milestone not only for the US financial system and markets, but also for the global system and markets as the RBA rate hike was for the Australian system this week. Rising inflation rates amid supply-side shocks from the pandemic and systems overburdened with liquidity have forced central bankers into their hands.
Because technology stocks have the most optimistic projections of their long-term prospects, they are the most vulnerable — as this year’s Nasdaq market performance shows.Recognition:`
Those most vulnerable to rapidly rising interest rates are those that have benefited most from ultra-low interest rates, particularly tech stocks.
That’s because their value is determined by discounting their projected future cash flows to calculate their net present value using an equation whose key input is the 10-year interest rate. When interest rates rise, cash values fall.
Because technology stocks have the most optimistic projections of their long-term prospects, they are the most vulnerable — as this year’s Nasdaq market performance shows.
Musk has waded into the sea of risk and uncertainty that the change in monetary policy is bringing about with what seems more like a vanity purchase than a sober business decision, offering $44 billion funded by a mix of debt raised by Twitter’s own assets are secured by cash flows, its own money (he sold billions of dollars worth of Tesla stock last week), and debt, collateralized by some of Musk’s Tesla stock.
As interest rates continue to rise and liquidity is withdrawn, many investors, corporate executives and policymakers with little experience of what “normal” monetary policy environments look and feel will be put to the test. Some will not enjoy this experience.
Twitter is loss-making and had negative cash flows for the past year, but would now have to service a far larger debt load if the deal goes through. Tesla shares, which represent both Musk’s wealth and his ability to secure cash and funding for the deal, are trading at more than 120 times earnings. While Tesla’s recent financial performance has been impressive, it makes the stock price vulnerable to changing monetary conditions.
Musk is a successful risk-taker, but it’s brave or foolish to take on Twitter at such a delicate financial and market moment. If he can’t dramatically improve Twitter’s financial performance, it could end badly for him, Twitter and Tesla shareholders.
Of course, changing the external settings doesn’t just affect Musk; Bidding for Twitter is just the most prominent and timely opportunity to reflect on how the radical and abrupt changes in monetary policy might affect the real world.
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In the absence of a new twist in the pandemic or a global geopolitical crisis arising from the war in Ukraine, the policies of the major central banks are set. It is being dictated to them by inflation rates that are at their highest in decades and are likely to remain so until central bankers bring them down with much higher interest rates and much tighter monetary conditions than today.
This will inevitably have repercussions for stock markets, bond markets and real economies, which have become accustomed to and comfortable with a long period of unconventional monetary policy and ultra-low interest rates.
As interest rates continue to rise and liquidity is withdrawn, many investors, corporate executives and policymakers with little experience of what “normal” monetary policy environments look and feel will be put to the test. Some will not enjoy this experience.
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