How US Federal Reserve rate hike can trip India Inc

The worst-kept secret in the financial world is that the Federal Reserve is all but sure Wednesday to raise interest rates from record lows by a modest quarter point.

Even with a gradual pace of increases, the Fed’s benchmark rate may not return to its historical long-run average of 4 percent. During the next four months, it dropped to 5.7 percent. At the time, she thought “it was a good thing they met only every six weeks and not every single week, or the rates would be through the roof”. On Wednesday, it’s expected to modestly raise that range to between 0.25 percent and 0.5 percent.

Could mortgage rates follow the same course this time around?

A rate hike with the euro/dollar at 1.1 rather than parity makes Yellen’s job relatively easier as the strength of the greenback is not the top concern. It’s OK to wait and see, and see how risk markets react.

As far as investments, some volatility is expected in the markets.

But weak growth globally – underscored by plunging oil prices – poses risks to a USA economy that has yet to completely shake off the effects of the last recession, economists said.

If you look at the chart below, you can see that during Fed tightening cycles (the gray shaded areas), interest rates on new cars, mortgage, and credit cards increase to varying degrees. In this occasion, while the Fed had already been hinting at a rate hike, the timing and the magnitude of the hike came as a surprise to the market. “When the Fed starts raising rates, that’s not something they’ll do unless they think the economy is sufficiently strong to absorb that increase”.

We’ve seen the deployment of large-scale asset purchase programmes by central banks – you might know this as quantitative easing – to help support economic growth and lift inflation. So if you want to sell your bonds before maturity, these high interest rates aren’t suitable for you.

Wake points out that often what people expect determines what they do. “A rate increase is a sign that the economy has continued to improve generally”. That’s down a bit recently, following a terrible week in USA and global markets – terrible, in part, because of an expectation that the Fed will move.

Economists in the survey are more optimistic, with their median estimate showing the equilibrium real interest rate at 2 percent.

For example, student loans tend to be offered at a fixed rate. Instead they ride along with the yield paid on 10-year Treasury notes. It has remained below 4 percent since late July.

Some economists say emerging markets like India have already factored in U.S. interest rate hikes in their economic plans. It makes pricing power for wages nearly impossible.

Will higher interest push the USA economy back into a recession? That’s the world we’ve been in for [nearly] a decade. Now, after a gap of seven years, the rates are set to move higher. That’ll tell you really how challenging it is for price increases to take hold.

It is very important to understand that the 30-day federal funds futures is merely one of the many barometers used to judge rate hike timing.

He has admitted that the floor they will attempt to put underneath market interest rates is “soft”, and the central bank could lose control on occasion.

Many investors are taking no chances. Ms Yellen is among the Fed officials who have admitted that its size will be “elevated” when rates do begin to rise. “It’s how that first move translates into market expectations about the future path of rates”. Everything is going to be just fine.

Fratantoni is especially curious about what the Fed will do with its balance sheet.

Dan Moisand, a Suntree-based certified financial planner and past national president of the Financial Planning Association, has a simple message for investors when rate hike is likely: Don’t fear the Fed. “There’s no investor of comparable size waiting on the sidelines ready to jump in”.

A rate rise will mean a higher cost of borrowing for companies. “But at this point, it’s going to be just a very modest headwind”. With most other aspects of macroeconomic policies essentially frozen due to political constraints – particularly fiscal and structural reforms – it will be up to the private financial markets to reconcile the policy divergence. A review of the changes in the Fed funds rate shows that both up and down cycles can last several years. And so what a rate hike does from a bank’s perspective is it gives them the opportunity to breathe a little bit of life back into that margin.