Should You Be Concerned About U.S. Interest Rate Hikes?
The Interest Rate Conundrum
The Fed under Janet Yellen indicated that U.S. interest rates may be raised in June 2015. This move has far-reaching implications for emerging market economies, investors and forex traders the world over. For starters, it’s important to understand why interest rates matter and why the Fed is thinking of raising them in the first place. Interest rates are important monetary policy tools used to increase or decrease the supply of money in the economy.
When interest rates are slashed, the velocity of money flow increases and economic activity is boosted. Since lower interest rates theoretically make it easier to access funding from banks, investment expands. In this particular case, more USD weakens the exchange rate value of the greenback in the U.S. Dollar Index. This is because oversupply drives values down and strengthens other currencies against the USD.
A weaker dollar is good for exports of US goods to international markets, but it bodes poorly for imports since more USD is needed to purchase those same goods and services. By dropping interest rates, more people are likely to punt on the stock market since there is little to be gained by keeping your money in banks and financial institutions that pay fixed interest. The U.S. is also less attractive to international investors when interest rates are lower since the stability of the U.S. financial system pays less than other economies offering higher yields on invested funds.
Interest Rate Hikes and Your Money
But how does an interest rate hike impact your investments and global economic activity? As a U.S. investor, an interest rate hike will allow you to earn more interest on your invested money. It also allows U.S. investors to get more bang for their buck on international stock markets and overseas investments. Since the dollar is stronger relative to a basket of other currencies (as it currently is in the U.S. Dollar Index) dollars have greater buying power.
However, since the U.S. is now more attractive to international investors, they will be selling their currencies and buying dollars for the purposes of investment. This is especially true given the expected hike in June 2015. In Europe, the euro is reeling and QE policies to the tune of €60 billion per month are being implemented to stop deflation, boost the velocity flow of money and raise economic activity. An inflation rate of 2% is being targeted by the ECB. However, an interest rate hike in the U.S may undermine investment activity in Europe and funds may shift to the U.S. instead.
Emerging market economies are the ones most likely going to be hit hard by an interest rate hike in the United States. Since emerging market economies are viewed as volatile, they are first in line to take a hit when interest rate increases in developed economies are adopted. Investors tend to shy away from countries like South Africa, Brazil, Mexico, Turkey, Russia and others as these economies are fraught with structural problems, currency instability and less than efficient management. The currencies of these emerging market economies are likely to devaluate as June approaches, which will impact forex currency pair trades across the board.
Sage Investment Advice for Americans and Europeans
For currency traders the time is fast approaching to go long on the USD, and short on emerging market currencies. U.S traders will be looking to bolster their investment portfolio with a mix of CDs, investments in stable overseas stocks and funds, and take out loans and mortgages before the interest rate hikes kick into effect. Europeans will do well to keep a mix of dollar-denominated stocks, currency and U.S. fixed-interest bearing investments too.
Author’s Bio: Brett Chatz is a graduate of the University of South Africa, and holds a Bachelor of Commerce degree, with Economics and Strategic management as his major subjects. Nowadays Brett contributes from his vast expertise for the globally renowned spread betting and CFD trading company – Intertrader.