turbi111
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What are the possible consequences of the imminent FED rate hike?
Now that the FED is getting ready to increase the interest rates I want to discuss what are the effects of an interest rate hike in the U.S. in both the real economy and the financial markets. I will also illustrate the possible effects that this hike will have in the markets around the world.
U.S. Real Economy
Banks will pass the increase in interest rates to the consumers and businesses, which will mean higher borrowing costs. Loans, credit cards, and mortgages among other obligations will have higher interest rates. This will leave less available income in the hands of businesses and consumers, causing a decrease in consumption and investment.
Saving accounts will become more attractive due to the increase in the interest received. For the retired people that live in their savings, an increase in interest rates is great news.
The increase in interest rate will also increase the cost of financing the U.S. government borrowing.
The most likely result would be a future increase in taxes or a cut in government spending .
Finally, the U.S. dollar will appreciate against other currencies (it has been doing that since mid 2014). This is positive for importers but negative for exporters, so the balance of trade worsens as exports decrease and imports increase.
U.S. Financial Markets
Just as the consequences to the real economy are quite direct, the ones to the financial markets might be a little more uncertain. We already experienced periods of increasing interest rates and the data on financial assets prices is not uniform. However, ceteris paribus, we expect the following developments in stocks and bonds:
Stocks – The most used method to value companies in Wall Street is known as DCF. In DCF, the interest rate is used to discount the future cash flows of the companies to the present in order to achieve a value. If the interest rate increases the present value of the future cash flows decreases resulting in lower stock values. So, as shown in the seeking alpha article Crash: Not So Sure. Correction: Sooner Rather than Later: “the hike on interest rates will have an immediate impact in the U.S. equities valuations, and a pretty fast reflection in their prices on the exchange.” In the following article: Fed Up: Do Rising Rates Matter to Stocks? You can find a summary of how stocks performed in past similar situations.
Bonds – Banks will adapt to the new interest rate environment and issue debt obligations with higher interest rates. This would mean that the already existing issues of bonds will not be competitive at their current price since no one will want to pay the same price for a bond that offers less return. The result: a drop in the existing bond’s prices. For those bondholders that are holding to maturity, these fluctuations in the price of bonds will not matter, as they don’t want to sell their bonds in the market.
Read more - http://opseeker.com/blog/2015/08/the-fed-rate-hike-is-about-to-happen-so-what/
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Sat Oct 17, 2015 2:24 pm |
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christcorp
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Everything you said is true. However, most people see raising interest rates as bad. The truth is, that is exactly what our economy and country needs. Unfortunately, our government has put us in a hole and they screwed up.
Normally, you reduce interest rates to spur borrowing and stimulate an economy. That is true, but when the government does it, they aren't suppose to be borrowing money themselves. They did this with all the quantitative easing and printing money. So yes, raising rates would increase the government's debt rate. Again, they weren't suppose to be borrowing. When they lowered the rates, they also slowed down people loaning to the government, such as bonds, bills, etc. People, government's, companies, etc. Stopped buying government securities.
But for the real economy, a rate hike would be good. As you said, savings and investment rates would go up. All those who were expected to borrow by lowering the rate but didn't, would probably jump to borrow before it went up even more. That would spur the economy.
You can't have 0% interest forever. You need inflation and deflation. You need a cycle. If not, prices would continue to rise for inflation and milk would be $20 a gallon by now. And if the price and interest stayed low, there would be no economic growth. Wages stagnate and money isn't moved around. When rates go up, people invest. When rates go down, people borrow. But when you keep rates down, eventually borrowing is maxed out because peoples income and investment slow. It has to be a back and forth balance.
But what screwed this economic cycle up, was the government. They used the low rates to increase their debt and spend more than they could afford. Just like the housing loan screwup where they were letting people making $50k a year get a $300,000 mortgage and buy homes they couldn't afford. Also, the government screwed up by bailing banks and companies out. There is no such thing as too big to fail. If a bank or company goes under, another will take over their assets and liabilities and continue on. In a capitalist economy, which is the best, you have to allow failures and growth to happen. You can't manipulate it.
So we're are now in a situation that the government screwed up and put us in. To fix it, the government needs to raise rates, they have to reduce spending, they need to promote investing in government securities as well as commercial investments. But most of all, they need to balance their budget and reduce debt. The current administration has accumulated more debt than all others combined. Whether you hate bush or not, when he left, the debt accumulated since the beginning of time, was around $7 trillion. Now it's over $18 trillion. You can't more than double the debt in less than 7 years and expect growth or economic stability.
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Sat Oct 17, 2015 3:14 pm |
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Veritize
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Joined: 02 Nov 2015
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Fed interest rate hikes usually lead to short term selloffs, but it also signals that the economy is healthy enough to take a bit of a hit. In the long term, raising interest rates controls inflation, and also gives the fed a tool in their utility belt to stimulate the economy when times are rougher.
Perpetually staying at 0% interest isn't a good long-term strategy, and if the market is unsteady, you can't lower interest rates to stimulate growth.
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Thu Nov 19, 2015 6:52 pm |
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