Speculation has been surrounding an early rate hike from the US Federal Reserve, with it being suggested it could be as early as September, investors are waiting to see how the markets would react with a tighter monetary policy in nearly a decade. Here are five things you should know about the impact of a Fed rate hike...
Investments down
As interest rates go up, it becomes more expensive to borrow money in order to finance investment projects. This would lead to companies financing fewer investment projects, leading to a fall in the overall level of investment. This also ties in with the volatility in stock markets as any rate hike is not good news for stock markets. Low interest rates mean companies can get credit cheaply but if rates go up, companies have to resort to cash on their balance sheets or issue shares and bonds to raise capital. This can put pressure on the companies’ balance sheets and overall expenses.
Mortgage rates could rise
Just as the Fed is signalling a rate hike, home buyers are rushing to get their mortgage applications approved in order to take advantage of a lower interest rate. But when the rates rise, it will become more expensive to borrow money leading to a fall in residential investment. Housing data from the US has shown investment in real estate has been a key driver in the US economy recovering from the crisis and an early rate hike could slow the recovery down.
Good news for savers
Increasing interest rates is always good news for savers. Savers have suffered since the financial crisis as their money in the bank have not gained a great amount. When interest rates go up, those who rely on interest on savings do better. The average interest rate on a savings account is a mere 0.44 per cent right now, according to Bankrate. But with speculations of a rate hike, this could go up and will make savers happy.
Stronger dollar
As interest rates go up, the value of the dollar – compared with other currencies – tends to increase. While a stronger dollar is good for American consumers looking to buy foreign goods and go on vacations abroad, it is also a danger because it could become harder to sell US made products globally. This could hurt American exporters with the result the balance of trade worsening as exports fall and imports rise.
Emerging markets in tough spot
When the Fed announced its decision to start tapering its bond-buying program, a number of emerging markets were badly affected due to a stronger dollar. This led to Indonesia, Brazil, Russia, India and Turkey being grouped under the term ‘Fragile Five’. While these countries have now slowly come out of this group and have tried to strengthen their economy, analysts still warn of a tough phase ahead for these countries.
Question: Why does the Fed need to hike rates then?
Keeping interest rates too low for a long time has its own set of dangers. As the economy recovers and reaches full employment, low interest rates could lead to excess demand, an overheated economy and inflation. If the timing of the rate hike is right, it could mean an economy with full employment and no increase in inflation.
However, there is a constant battle between inflation hawks who want to raise rates sooner rather than later and others who want to be patient with raising rates. Investors are stuck between this battle and an outcome is yet to be seen. But for now it seems a Fed rate hike would mean savers could be winners and borrowers could be losers.
