A new financial dawn for millennials

Rising interest rates will pose a challenge for millennials that they have not encountered before.

By Ronan Kelly Bank of Ireland Global Markets

Millennials make up a significant proportion of the Irish population – somewhere in the region of 25% to 30% based on the 2016 census.

Although no exact definition exists, millennials can be roughly defined as people born between the early 1980s to the late 1990s. Some definitions may even stretch to the early 2000s.

As such, the vast majority of them either entered adult life during the global financial crisis or started their careers since then.

Now aged from their late teens to late thirties, this generation, of which your author counts himself, have lived all their lives to date in a period of historically low interest rates.

For most, interest rates have either fallen or moved sideways for the entire period they could amass debt.

Despite the recent delay to rate hike expectations for Europe – the ECB now projects a first move in 2020 – interest rates are likely to rise in the coming years, which will pose a challenge for millennials they have not encountered before.

Dealing with economic cycles 

Of course older generations will rightly point out that economic cycles are nothing new; and all previous generations have had to deal with rising, and falling, interest rates at some point. That is true.

The subtle difference however is the length of time rates have spent falling or stuck at historically low levels in the current cycle.

No generation in modern history has been comprised almost entirely of individuals whose adult lives has been accompanied by both easy monetary policy and improving ease of access to credit.

Having known nothing different, it is too simplistic to merely assume patterns from previous decades will repeat themselves when it comes to the millennial generation.

The benefits of low interest rates have been broad, particularly for millennials accumulating new net debt. For individuals, mortgage rates have trended lower, personal loan rates likewise.

As the economy improved from the trough set in the early years of this decade, so too did car sales. First time buyers who, perhaps unshackled from the rigorous process of deposit saving and financial prudence required to get that mortgage, upgraded their cars, availing of favourable financing conditions. Banks have turned the corner into net loan book growth.

With traditionally safe assets – government bonds etc. – offering smaller scale returns for investors due to low central bank interest rates and quantitative easing (central bank bond purchases) – non-bank lenders have entered new markets to improve shareholder returns, in the process adding to competition and the economy’s access to credit.

Away from personal finance, the entrepreneurs among the millennial generation have set up businesses. From basic finance facilities to more complex debt and equity funding, the required return or yield demanded by investors has largely fallen, at least in outright terms.

For the larger firms, of which a small number of millennials control but a more significant number have a deciding say in internally, corporate bonds have become an increasingly attractive, and relatively cheap, source of funding.

An unknown for policy makers

The reaction function of millennials to higher funding costs poses an unknown for policy makers. How an entire generation reacts to the prospect of more expensive credit is uncertain – there is little or no historical data on which to base predictions. There are signs the impact may be larger than expected.

While difficult to separate millennials from the rest of the population when looking at aggregate data, it is fair to assume that given their age and stage in life, they have a statistically significant impact on the reaction function of the economy as a whole.

In both the US and Canada, the recent cycle of rate hikes came to an abrupt halt, at least temporarily, as the impact proved greater than previously expected.

For individuals here in Ireland, who count themselves as millennials, now is a good time to consider the impact of higher borrowing costs in the years ahead. In the financial world, hedging interest rate risk is a relatively straightforward concept, if not always straightforward in action.

For the rest of the economy, it is often an overlooked idea until hindsight sets in. In simple terms, fixed rates loans are in essence a hedge. What is the difference between a variable loan and a fixed rate loan? Certainty.

For businesses and corporates, the same is achieved by entering an interest rate swap, removing the floating element of debt obligations.

Not everything can be hedged, nor may it be desirable. However, knowing what options are available and understanding the impact of one’s own exposure to rate hikes will help make informed decisions in the months and years ahead.

The financial wellbeing of millennials will become an increasingly important factor for the economy as a whole as this entire generation becomes part of the working population.

As a generation that has proven adept at navigating disruption across various aspects of life, there is good reason to believe they will overcome many of the challenges faced by higher interest rates.

Of course, that assumes millennials are equipped with the knowledge and resources required. Generation X and baby boomers would be well advised to remind millennials of previous cycles; and for millennials it would be prudent to listen.

Ronan Kelly works in global interest rate trading at Bank of Ireland Global Markets. 

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