Interest rates are a threat to equities The rise of EIBOR

The major theme for equity markets over the last couple of years has been the oil price. That was a valid issue as it affected the fiscal side of the economy tremendously (i.e. government spending).

Various other issues have cropped up in terms of looking at the market, such as the tightening fiscal policy of introducing VAT and the investor trust levels post the Abraaj issues. Fiscal policy will have an impact, Abraaj is really about learning from their mistakes.

But there is another threat, one that is growing, and that is interest rates. The US Federal Reserve (Fed), the central bank of America, has been countering Trump’s loosening fiscal policy of reducing taxes by moving towards a more contractionary monetary policy of increasing interest rates. This makes sense for the US which has a robust economy these days. For us, and other countries pegged to the US dollar and facing a challenging economic environment, increasing rates are a problem.

The basic issue is that if the interest rates on bank deposits begin to rival the return on equities, then rational investors will move their money from equities into bank deposits. Especially since bank deposits are, on the average, far less risky than equity.

In the UAE, the reference rate is the Emirates Interbank Offer Rate or EIBOR for short. The Central Bank of the UAE has appointed Thomson Reuters to calculate EIBOR daily, called a fixing, by sampling rates from various banks. As of the writing of this article, 1 year EIBOR is c. 3.3%, up from 2.1% a year ago.

What makes things worse is that the Fed has indicated that it will raise interest rates several more times. Companies have probably forgotten what it means to compete with bank deposits. They need to generate the same equity premium over the risk-free rate, and when the risk-free rate goes up, guess what? Company returns need to go up.

But this is not about a single stock. Year to date the Dubai Financial Market Index is down -13%.  A complete operational overhaul of businesses is needed to compete with bank deposits. This applies to many public and private companies.