US rate hike

On 15th March 2017, the Federal Reserve is widely expected to raise interest rates for the first time in 2017. Many markets such as currency market, the gold market and stock indexes have started showing speculative moves ahead of the Fed rate decision. Almost all of them factoring in a possible rate hike.

Will there be a market turmoil? 

  • On 15th March 2017, the Federal Reserve is widely expected to raise interest rates for the first time in 2017. 
  • Many markets such as currency market, the gold market and stock indexes have started showing speculative moves ahead of the Fed rate decision. Almost all of them factoring in a possible rate hike.

Is the Interest Rate Low in the US?

  • The financial crisis and the Great Recession officially ended in mid-2009. Necessitated by this, the Fed took the rate to 0.25 percent from 3.5 percent  exactly seven years ago, on Dec. 16, 2008. 
  • Fed began increasing the interest rate in 2015 by 0.25 percent bringing it to 0.5 percent. Later in 2016, the Fed increased the interest rate by another 0.25 percent bringing it to 0.75 percent.

Why does the Feb Want to Increase the Rate?

  • For a healthy economy where the GDP grows between 2 to 3 percent annually, the interest rate has to be maintained between 2 to 5 percent. Currently US Fed rate is 0.75 percent. This is in itself is motivation for the Fed to increase the rate. 
  • Price increases remain below the Fed's inflation target of 2 percent for the core inflation rate. Hence, the Fed seems poised to increase the inflation rate. The decision may also be supported by the economic indicators that tend to present US economic healthy getting better. 
  • The promise of increasing interest rate is by itself a tool to bring back money parked in foreign assets. Hence, after long period of promise with no delivery, it seems fit for the Fed to increase the interest rates. 

Assessment

US Fed rate hike is an event most traders and investors are cautious about. This is because, the decision to increase the rate or maintain the rate without rate hike may have financial implication on multiple markets. Firstly, the most prominent impact is on the currency value. An increase in the rate implies increase in the cost of the funds in dollar terms which would mean an increase in the value of dollar against most other currencies. Secondly, since gold is a safe haven for investors, gold may loss value in the market as investors factor in the shift of focus from gold buying to parking funds in dollar due to the expected rate hike. Thirdly, an interest rate hike may reduce the arbitrage in investing in international stock markets. This may cause a sell out in the stock markets. Trading ahead of the rate hike demands caution. 

 

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