Economic realities are being redefined with the Fed’s recent interest rate hike. Now that the Federal Reserve Bank has decided to move on interest rates, the global markets are going to be playing by an entirely different set of rules. For starters, the rate hike of 25-basis points has far-reaching implications for the USD. Foreign currencies are being sold en masse to buy greenbacks, thereby driving up the demand for the USD and causing it to appreciate on the global arena. That the USD is the world’s reserve currency is an important point: dollar-denominated commodities are also impacted by the rate hike. Commodities like gold, silver, crude oil, copper and iron ore are all priced in USD and when the dollar appreciates, these commodities become relatively more expensive to overseas buyers. This causes the demand for these commodities to fall.
What are the Implications of a Fed Rate Hike?
But there are many other implications of a Fed rate hike, several of which are overlooked by casual investors and traders. For example, the Fed typically sets the stage for other central banks to act. The Bank of England (BoE), the European Central Bank (ECB) and the Bank of Japan (BoJ) typically wait for the Fed before making important monetary policy decisions. A particularly interesting case is the European monetary policy of quantitative easing. At the beginning of December, the president of the ECB Mario Draghi made good on his promise not to allow the euro to collapse. The objectives of the ECB are to stabilize the euro and increase the rate of inflation in the eurozone towards the 2% mark. To achieve these important macroeconomic objectives, the ECB enacted two important measures:
- A 10-basis point rate cut in the deposit rate to -0.30%
- An extension of the asset repurchases programme valued at €60 billion per month for an additional 6-month period
The Bank of England is expected to act by the end of 2016, when it will likely raise interest rates above the 0.50% level. There are however several important realities facing the UK economy, notably the over-valued housing prices in the London metropolitan area and the issue of UK pensions. UK traders are waiting for housing prices to return to normalcy in the near future, with property widely considered heavily overpriced at present.
How the US Economy Fares Against the EU Economy
The GDP of the US economy and that of the EU economy are moving closer together. The US economy is growing at a rate of 2.25% to 2.50% whereas the Eurozone is growing at a rate of 1.80% per annum. But there are real concerns among analysts that the US economy will suffer through a recession within the next 12 to 24 months, according to credit rating agencies. The biggest problem facing the US economy is that of manufacturing PMI data. Services PMI in the US are robust and many folks mistakenly believe that services PMI can drag the manufacturing component into the black.
Meanwhile, in Britain a debate is raging as to whether the island nation should leave the Eurozone. The so-called Brexit is fast gaining traction among a growing contingent of voters. Everyone will invariably keep their eyes on China as the world’s #2 biggest economy pivots away from export-driven growth to consumer-centric growth. The IMF still considers China a powerhouse in the economic arena with growth in the region of 6% forecast for 2016. Meanwhile, there are some new realities taking shape in the US: consumers are finding it increasingly difficult to put down the money for a deposit on a home so instead they are renting and sharing accommodation and spending more of their PDI on things like coffee shops, restaurants and leisure activities.