WHAT DOES A FED RATE HIKE MEAN?

May 25, 2016

This week the minutes from the Central bank’s meeting in April showed that a hike at the June meeting would be ‘appropriate’ if economic conditions continue to strengthen as inflation rises closer to the 2 percent target. However, several policymakers indicated their concerns that the economic signals may not be clear enough by the June 15 meeting. The upcoming UK referendum on its membership in the EU is the biggest overseas factor giving the Federal Open Market Committee (FOMC) jitters for next month. According to the Fed, the median predictions from the March 2016 meeting were a hike to .875% by the end of 2016. Rates in the US have been historically low since the 2007-2009 financial crisis: so what do higher interest rates mean for businesses and consumers? On the business side, many corporations have taken advantage of the low rate to borrow money via the bond market, and feel that a small rate hike will have a negligible impact. Economists however warn that the interest payment for companies who have issues low-grade debt could rise quickly. An upward trend in short term interest rates will be positive for savers who have been seeing negligible interest on their deposits, but this could be a knock-on for other interest rates like car loans, credit cards, and mortgages, which could make them more costly to consumers. OECD statistics however show that the burden of household debt has fallen since the crisis, suggesting that consumers are better prepared for higher borrowing costs.

On a global scale a rate hike would lead to widespread expectation that the Bank of England will be the next central bank to raise rates after the US. The Bank of England typically follows the Federal Reserve’s lead, when measured by government bond yields. At the most recent meeting the Bank of England’s monetary policy committee unanimously voted to keep interest rates at historic lows of 0.5 percent, and JP Morgan believes a rate rise won’t come until the first quarter of 2017. A rise in the rate in the US would impact emerging market countries through the stronger US dollar, which we are already seeing. Higher US interest rates a stronger dollar will depress the values of emerging market currencies at a time when they are already weakening against the greenback. The fed rate hike could exacerbate currency turmoil.

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