Winners and losers if and when Fed acts

THE US Federal Reserve Bank is expected to raise interest rates at its meeting this week — its first hike since 2006.

A key indicator for monetary policy decisionmaking in the US, the unemployment rate, has continued to post solid monthly gains, leading many to believe that rates will be hiked this month. The unemployment rate fell to 5.1% in August, the lowest rate since 2008.

However, the recent turmoil in global financial markets has led to concerns that a rate hike could add to market volatility.

At this week’s G20 group of leading economies meeting in Turkey, the IMF warned that higher interest rates could damage the already fragile economic recovery. The fund suggests that monetary policy should remain accommodative to prevent real interest rates from rising.

Nobel-winning economist Joseph Stiglitz, a professor at Columbia University, argues that global economic forces are poised to drive inflation lower, and the preponderance of economic data indicates that the predictable cost of premature tightening — slower job and wage growth — far outweighs the risk of accelerating inflation.

Indeed, oil prices reached $42 recently, a low last seen in February 2009.

In the US, price growth for personal consumption expenditures excluding food and energy has averaged less than 1.5% annually in the recovery, well below the Fed’s unofficial 2% inflation target. Thus far this year, the rate has slowed to 1.3%.

It would therefore make sense to hold off hiking rates because inflation remains low and the dollar is rising. A hike could see a stronger dollar, which would ultimately hurt US exports and put a brake on growth.

The implication of a rate hike for emerging markets is dire. Should the Fed hike rates, the dollar will appreciate, encouraging global investors to pull their money out of emerging markets and invest in the US.

If a strong dollar persists for long, then dollar-denominated debt owed by emerging markets may get severely impacted.

Data from the Bank of International Settlements shows that emerging market borrowing doubled in the past five years to about $4.5-trillion (about R62.4-trillion).

This means that local currency devaluation caused by a reversal of capital flows can make servicing this dollar debt more difficult.

Countries such as Brazil, Turkey, Indonesia, South Africa and Russia would face tough economic conditions due to high borrowing costs, and commodity exporters such as Brazil, Russia and South Africa will be worse off as they face the double whammy of a strong dollar and a weak China.

Furthermore, corporations and banks that borrowed in dollars could be facing additional pressure if they don’t have matching revenues or assets.

So is there any compelling reason for the Fed to raise interest rates? The answer is yes. A rate hike would end market anxiety over the Fed’s first rate hike move in nine years. Postponing the rise in interest rates because of global economic turmoil would diminish faith in recovery and policy normalisation. A rate hike might also chart the beginning of a long-term adjustment of monetary policy to rising inflationary pressures.

The international environment, which the Fed takes into account in rate setting, is not universally negative and of course there will be winners and losers. Countries that have reinforced their economic fundamentals will do better than others, thus helping financial markets to differentiate between economies.

All eyes will be on the Fed on Wednesday and Thursday.

Leoka is an economist

Thabi Leoka