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How US interest rates influence the world economy and why you should care

November 2017


Tags: Macro Economics

Eight times a year the Federal Open Market Committee sits to decide on US monetary policy.

The committee, a part of the US Federal Reserve, has responsibilities which include setting interest rates and providing financial stimulus for the economy. Its first meeting is typically in late January and its final meeting in mid-December.

Financial markets across the globe, including in London, will respond to the latest decision from the Federal Reserve or Fed which is announced around 6pm Greenwich Mean Time.

 

Higher rates can boost currency

Higher rates will usually increase the value of a country’s currency. The increased return on offer attracts foreign investment, inflating demand for and the value of the home country’s currency.

As well as impacting foreign exchange and signalling a view on the economic backdrop, interest rates also have an impact on the way different assets are valued and on the spending habits of consumers and businesses.

When rates move higher interest charges on borrowings will also increase and this leads to spending being scaled back.

If people are buying fewer products and services or if investment within businesses declines then estimated cash flows for most listed companies will likely fall and this will typically result in lower share prices.

An increase in rates should also boost the return from assets such as cash and bonds which are typically seen as being lower risk than shares. In these circumstances investors may choose to take their money out of the stock market.

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Most widespread and profound impact

US rates have the most widespread and profound impact globally thanks to the country’s status as the world’s largest economy and because many currencies, particularly in the developing world, are tied to the US dollar and many emerging markets hold a lot of their debt in dollars.

This was illustrated in stark terms in May 2013 when the then chairman of the US Federal Reserve Ben Bernanke hinted he would reduce an $85 million financial stimulus programme (a likely precursor to lifting rates). The dollar rose and riskier assets, particularly those in emerging markets saw a big sell off.

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Writer: Tom Sieber Tags: Macro Economics

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