Finally U.S. interest rates headed higher, following years of control over the policy rates. But what could that mean for the U.S. and the global market?
Since the outbreak of the recession in 2008, almost all major economies were affected including the U.S. The Federal Reserve remained hesitant on increasing the rates for years, creating an alarming suspense over the market. When the Fed finally took the decision of hiking the rates, the news spread throughout the market and grabbed the attention of most investors and traders. This hike in rates was the slowest and most gradual in history.
Yes, the hike in interest rates occurred, but how frequent will this occur and when shall it stop? This remains the pertinent question which is playing an important catalyst in the global market. All the previous obstacles that held back U.S. economy have now gradually diminished as U.S. economic data indicate progress and a healthy economy. Ingredients needed to sustain a potential growth in the interest rates were satisfactory and sufficient enough.
The Federal Reserve
The Federal Reserve kept the current global situation in mind and also monitored the inflation rate so as to further raise the rates. Fed will try to normalize rates gradually in order to produce a more acceptable economic expansion. Over the years to come, Fed will adopt same measures to increase rates so as to create the balance between inflation and interest rates for U.S. as it is the the biggest economy of the world.
The range of its benchmark interest rates was raised by another quarter of a percentage point, shifting from 0.25 percent to 0.50 percent. In the U.S., Board of Governors of the Federal Reserve and the Federal Market Open Committee (FOMC) are the respective bodies that examine the interest rates and take the decision to raise them or not. The committee evaluated the current economic situation of the U.S. and draw a conclusion that the labor market has had considerable improvement and the Fed is confident that the U.S. will achieve the inflation rate target of 2 percent.
The current global economic outlook pushed Fed to raise the barrier of interest rates in the best interest of the U.S. economy. Given the time it takes for policy rates to affect future economic projections, Fed deemed the raise in rates imperative. Hike in rates support the growing labor market and projection of a 2 percent inflation rate. Fed policymakers have also added that these rates are going to remain around the same reading for some time and only gradual hike in rates will be done, depending on the economic data outcome for U.S. Janet Yellen, the chairperson of Fed, showed that she still has confidence in the U.S. economy and was the person who supported increase in the rates, the most.
The U.S. Economy
The Federal Market Open Committee had a meeting in October which was about the progress of the U.S. economy. Conclusion was that the U.S. economy expanded at a moderate rate, accompanied by good reading for household spending and expansion in the labor market. Thus, it became obvious that the FOMC was optimistic for the interest rate rise and once the word spread over the market, investors became interested with the binary opportunities that could help the market rally.
Most economic indicators for the U.S. looked positive and amongst the major releases, most were up to the standard as:
- • Labor market was steady - with the Nonfarm Payrolls soaring higher in October
- • Housing sector improved
- • On-going job gains were reported
- • Declining unemployment, which is a good sign
The gradual adjustments in the U.S. economy paved way for a hike in the rates after almost 8 years. Many other major economies were reluctant in doing so and awaited whether the Fed will normalize rates in December, before contemplating of doing the same. But given the global outlook this may well be difficult for other big economies. Reaching 2 percent inflation has been difficult for the U.S. as well since there has been a decline in energy prices and non-energy imports. The U.S. shale industry has been the target for that matter since there has been a steep decline in crude oil prices worldwide. OPEC refused to cut on production, despite the fall in prices while U.S. crude suffered the same sort, with too much of oversupply not meeting the adequate demand. Else, other positive outcome for U.S. economic data kept hopes alive.
However, there is another scenario to increase in interest rates. Of course the stock market rallied and so did the USD, but at the same time it affected consumers’ and businesses’ psychology. After a rise in interest rates, often consumers tend to cut back on spending since lower interest rates helped them to take big loans and make huge purchases such as houses and cars. Even farmers benefit from a lower interest rates, since they are encouraged to make large equipment purchases given the low cost of borrowing. Interest rates affect borrowing rates on a large scale. A lender charges interest money when a borrower borrows money from him and this encourages him to lend money, while the borrower needs not save money on long-term and buy in large portions immediately. When output and production increases on the market, and there are no buyers, then supply will be larger than demand.
Coupled with that, inflation rate is also a matter of worry, as inflation refers to the rise in prices of goods and services over time. This happens mostly for economies which display a strong economic health, which the U.S. wants to project. However, if inflation does not match the required standard, it can result in loss of purchasing power as well.
The Global Market
Following the rise in U.S. interest rates, investors look forward to important economic gains as capital mobility increases. In the midst of economic growth and financial integration, many major economies wish to create substantial economic growth for their respective economy. However, a sustainable economic growth is the pertinent question here. Everybody wants a productive and stable economy and they want to see real development in the market sector.
Investors are of the opinion that economies and financial markets do not react in the same way. While Central Banks such as the Fed take important decisions, investors begin to analyze these changes and try to focus on how these alterations can actually deliver the exact outcome, that is having a stable economy whereby interest rates and inflation rate remain on the same line. Forecasts on economic activity and inflation becomes difficult when economies tend to lag behind in bringing necessary changes. However another wave in raising the standard of global economic growth is being seen.
Major economies are opening towards a better integration of economies, specially economies which have the potential of getting stronger and creating vital financial outcomes. This is important for emerging economies, as major countries possess the ability to raise prospects for long-run world growth. Development in the market sector together with developing economies offers adequate means to raise income growth and standard of living. U.S. has set example of a sound economy in the global market, urging many other economies to strive for the same. In a way, the United-States has curbed influences from external imbalances and concentrated on the behavior of the market and progress to raise its interest rates. Analysts have strongly observed the past tightening cycle of interest rates, but also agree that it was high time for the U.S. to do so. Now it’s time to focus on the current pattern of global capital flows and forces which might evolve over time. However, the U.S. cannot have a full control on how other economies gets affected over time and what implications it’s rise in interest rates may turn out to be for smaller economies. U.S. can become a role model, help where its influences reaches, but whether the global market is fully affected or not, remains an issue. Example is that the USD bounced following the interest rate decision, but quickly subdued in the following week and still stagnates against the JPY and GBP, though the greenback maintains its strength.
The Bottom line
Central Banks such as the Fed, has an important role to play for a large economy such as the U.S., but how clear does all that seems to be is still a mind boggling issue. Some economies do not feel the impact of interest rates and common people do not really even get affected. However, the U.S. has grown in strength and impacted the world economy by raising the rates. The next interest decision rate shall occur on 27th January 2016, but since the Fed announced a gradual growth, the reading might well stick around 0.50 percent.