The im­pact of a Fed in­ter­est rate hike

Financial Mirror (Cyprus) - - FRONT PAGE -

The Fed­eral Re­serve Bank is ex­pected to raise in­ter­est rates by a quar­ter per­cent­age point be­fore the end of 2015. Ad­di­tion­ally, US pol­i­cy­mak­ers ex­pect that in­fla­tion will re­main at his­tor­i­cally low lev­els for at least the next five years and the eco­nomic growth rate will in­crease at a de­creas­ing rate. These an­nounce­ments were pre­sented to pol­i­cy­mak­ers dur­ing the meet­ing that took place on June 16 to 17.

How­ever, these views are not shared by those who de­ter­mine in­ter­est-rate pol­icy in the US. These an­a­lysts and gover­nors – many of whom are out­side Washington – will gen­er­ate their own in­ter­est-rate fore­casts, growth rates and other eco­nomic pre­dic­tions. Based on the estimations of eco­nomic an­a­lysts, it is likely that the Fed will raise in­ter­est rates to 0.35 per­cent­age points by Q4, 2015. Presently the Fed funds rate is ap­prox­i­mately 0.13%. How In­ter­est-Rate Hikes Im­pact Eco­nomic Vari­ables The im­pli­ca­tions of in­ter­est-rate hikes are im­por­tant as they per­tain to the US dol­lar in­dex, con­fi­dence in the US econ­omy, and global eco­nomic pros­per­ity. Since the USD is the world’s re­serve cur­rency, any change in in­ter­est rates will in­evitably im­pact upon com­modi­ties prices, in­vest­ments in Third World economies, and busi­ness con­fi­dence in the US. Typ­i­cally, when in­ter­est rates rise, the cost of in­vest­ments in the do­mes­tic econ­omy be­comes more ex­pen­sive. In or­der to counter the ef­fect of in­creased bor­row­ing costs, ex­pected rev­enue pro­jec­tions must in­crease. More im­por­tantly for do­mes­tic hous­ing, in­creased in­ter­est rates im­ply that the costs of mort­gages and long-term loans will in­crease, damp­en­ing in­vest­ment in prop­erty. One of the most im­por­tant eco­nomic barom­e­ters is residential in­vest­ment. In­creased home sales in the US were piv­otal to the eco­nomic re­cov­ery that has taken place since the 2008 global cri­sis. Pol­i­cy­mak­ers Push for Rate Hike The Fed­eral Re­serve is in­ter­ested in main­tain­ing an in­ter­est-rate be­tween 0% and 0.25%. This rate is used as a con­trol mech­a­nism for short-term in­ter­bank lend­ing. In all, 15 of 17 pol­i­cy­mak­ers are in­tent on rais­ing in­ter­est rates for 2015, with the ma­jor­ity sig­nalling a de­sire for just one in­ter­est-rate hike. It is un­likely that the in­fla­tion rate will reach the Fed’s de­sired range of 2 per­cent­age points for the year, but GDP is ex­pected to in­crease by 1.74 per­cent­age points this year to Q4, 2020.

Ris­ing in­ter­est rates also de­crease the con­sump­tion of durable goods, be­cause the fi­nanc­ing costs are higher. In­creased in­ter­est rates will also add to Amer­ica’s na­tional debt for the same rea­sons.

On a pos­i­tive note, those with money in­vested in banks and fi­nan­cial in­sti­tu­tions will be earn­ing more in­ter­est, and those with strong dol­lar hold­ings in Forex will see the USD gain­ing ground against a bas­ket of cur­ren­cies as it be­comes the pre­ferred cur­rency. While this will cer­tainly hurt ex­porters, im­porters will be able to pur­chase more for­eign goods and sup­plies with fewer dol­lars. It’s a mixed bag, but the mo­men­tum is clearly with the green­back!

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