The Importance of a Fed Interest-Rate Hike
Investors and traders are cautiously eyeing the market for signs of an imminent interest-rate hike in the US. Conflicting comments from various policymakers, analysts and even the President of the Federal Reserve Bank of Boston have the pundits bamboozled. Stanley Fischer, the vice-chairman of the Fed has alluded to the need for an interest-rate hike, stating that economic conditions are ripe for such a move. However, Eric Rosengren, the Federal Reserve Bank of Boston’s CEO and President has other ideas. According to Dr. Rosengren, the timing of a rate hike is not set in stone. He is of the opinion that it makes little difference whether an imminent rate hike occurs or whether it is pushed back several months. His dovish comments are in favour of a modest monetary policy, owing to global instability, Chinese equity weakness and historically low inflation rates.
The Implications of a Rate Hike
Precisely why interest rates in the US are so important to global markets is a question that many novice traders and investors are consumed with. It is perhaps best answered by understanding the implications of an interest-rate hike on the US domestic economy, and the global economy. When interest rates rise, the USD becomes relatively more attractive than other currencies. This is because the yield on dollar-denominated assets in fixed interest-bearing accounts is higher. As a result, they dollar will appreciate and other currencies will depreciate accordingly. The impact of a Fed rate hike will cause capital to be diverted from emerging market economies such as BRICS countries (Brazil, Russia, India, China and South Africa) to industrialised nations such as the US and European countries. From a strategic perspective, a rate hike signals to investors that the safe money at least in the short to medium term is not in emerging market economies, or with the emerging market currencies.
At the domestic level, a rate hike is significant. The cost of mortgages, car loans, credit and investment capital becomes that much more expensive when interest rates rise. This has the effect of raising the rate of inflation, and encouraging saving. However, the downside is that people will be paying more for their mortgages, loans and credit facilities and that has a contractionary effect on consumer spending. The Fed has been targeting an inflation rate of 2%, and its monetary policy is geared towards achieving that end. However, contractionary manufacturing data was recently released in the US, the UK and China. The likelihood of a Fed interest rate hike now is somewhat diminished if one takes the global perspective into consideration. Stock markets around the world have hit multi-year lows, with the Chinese economy growing at its slowest pace in 25 years. That the authorities in Beijing have resorted to blaming rogue banks and financial institutions is testament to the deep cracks within the world's second-largest economy.
How is the US economy doing?
According to the Beige Book, there is stagnating wage growth in the US. Q3 GDP is unremarkable at just 1.3% and this follows after an estimated $3.7 trillion of quantitative easing injections into the US economy. Overall, high levels of debt, low levels of saving and slow income growth is plaguing the US economy. This does not bode well for a rate increase. There is an expectation of a 0.25 point rate increase before the month is over. The likelihood of a Fed rate hike has steadily dropped as September has neared, with analysts now pegging the chances of one at 27%. The likelihood of a rate hike by December has increased to 60%. However the Beige Book report was compiled before all the tumult in Asian markets. Commodities will be impacted, notably dollar-denominated commodities like gold, copper, crude oil, silver and others which will become relatively more expensive, coupled with weak global demand. The effects of such a move could be disastrous when viewed from the perspective of current market conditions.