How US interest rates hike will influence business
The US central bank changed its stance on rate increases, but how will it affect the economy and businesses?
After years of rock-bottom rates the US Federal Reserve has finally modified its stance on interest rates and opened the door to a potential hike this year, perhaps even as early as June, although the likelihood remains rather low. An increase in interest rates is definitely on the US horizon, but how will this impact the American economy?
To begin with, let’s look at how the announcement affected markets.
Stocks in US markets soared in the initial reaction following the Federal Open Markets Committee meeting on Wednesday evening and the dollar recorded its largest single-day decline in nearly seven years.
Investors ploughed in to the Dow Jones index on the back of the news, as businesses are set to benefit from prolonged cheap borrowing costs. The US dollar will inevitably strengthen from an increase in interest rates, as low rates mean low returns for those that hold dollar denominated assets.
Despite this, a coming rate rise indicates the world’s largest economy has significantly recovered since the financial crisis. Jobs have returned alongside growth and, although there remains room for improvement, the US Federal Reserve believes the economy is strong enough to be able to support higher rates.
But what other impacts will higher interest rates have?
The effects of rising interest rates
We’ve already touched upon what an interest rate increase will mean for businesses, but there’s one thing that’s certain - the era of cheap loans is over.
No longer will you be able to access loans where the interest rate has been at such historic lows, while those that already have financing will likely see borrowing costs rise, unless they had the foresight to acquire fixed rate loans.
Credit cards, mortgages and student loans will all feel the effect of higher interest rates, but on the flip side the returns on savings will also increase.
As interest rates rise so will the US dollar, which has seen an incredible surge in the past year.
Businesses in the US, particularly those that export, have already been struggling. Their goods have become increasingly costly for importers from other nations, a stronger dollar could mean they will have to adopt new strategies.
Rate hikes point towards higher stocks
Judging from initial reactions, investors actually fear coming rate hikes. Stocks usually move lower when speculation ramps up that the Fed is looking to raise rates. A recent research note from investment bank UBS looked at market performance following initial rate hikes from the Fed going back to 1954, and the results were quite surprising.
The bank pointed out that shares move higher in the months following an increase to rates. It showed that the Standard & Poor’s 500 index climbed an average of 7.6 per cent in the six months following the rate hike.
So investors shouldn’t really have any worries as long as the Fed moves rates higher in a gradual process.
Timing is key
Speculators have had to push back estimates of when the next interest rate rise will come. The Federal Open Markets Committee continues to evaluate incoming data to judge whether the US economy is ready for higher rates.
Fed officials added that interest rate rises weren’t appropriate until seeing “further improvement in the labour market” and it would hinge upon “the committee’s assessment of incoming information”.
Some analysts believe that a combination of lacklustre data and low oil prices could further delay a rate rise. Others believe that there might not be a better time than this year.
“We think the Fed currently has a window of opportunity to move, with stable markets, payrolls growth at extremely high levels (and momentum improving), and foreign central banks (most notably the European Central Bank and the Bank of Japan) taking the reins of policy accommodation,” said Rick Rider, chief investment officer of fundamental fixed income at BlackRock.
“We strongly suggest that Fed rate normalisation will not only be borne well by the economy, but that it may actually hold a positive impact, while keeping rates excessively accommodative almost certainly holds an increased risk for markets,” he added.
It seems that higher interest rates means the US economy will continue to grow in strength. Stocks should rise alongside the US dollar and, as long as economic data remains positive, growth will likely flourish and take the US economy to new heights.